[Federal Register Volume 68, Number 116 (Tuesday, June 17, 2003)]
[Notices]
[Pages 35933-35937]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-15263]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48013; File No. SR-PHLX-2002-55]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change and Amendments 
No. 1, 2, and 3 by the Philadelphia Stock Exchange, Inc. to Initiate a 
Pilot Program that Allows the Listing of Strike Prices at One-Point 
Intervals for Certain Stocks Trading under $20

June 11, 2003.
    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 October 2, 2002, the Philadelphia Stock Exchange, Inc. (``PHLX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the Exchange. 
The PHLX filed Amendments No. 1, 2, and 3 to the proposal on March 17, 
2003,\3\ June 6, 2003,\4\ and June 10, 2003,\5\ respectively. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons and to grant 
accelerated approval to the proposed rule change, as amended, through 
June 5, 2004.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaces the original filing in its 
entirety.
    \4\ Amendment No. 2 replaces Amendment No. 1 in its entirety.
    \5\ See letter from Jurij Trypupenko, PHLX, to Nancy Sanow, 
Senior Special Counsel, Office of Market Supervision, Commission, 
dated June 9, 2003 (``Amendment No. 3''). Amendment No. 3 indicates 
that the proposal expires on June 5, 2004.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to initiate a pilot program (``Pilot 
Program'') that will allow the Exchange to list options on selected 
stocks trading below $20 at one-point intervals. The text of the 
proposed rule change appears below. Additions are in italics; deletions 
are in brackets.

Series of Options Open for Trading

    Rule 1012. (a)--(d) No change.
    Commentary:
    .01 to .04 No change.
    .05 (a) The interval of strike prices of series of options on 
individual stocks [will] may be:
    (i) $1 or greater (``$1 strike prices'') provided the strike price 
is $20 or less,

[[Page 35934]]

but not less than $3. The listing of $1 strike prices shall be limited 
to options classes overlying no more than 5 individual stocks (the ``$1 
Pilot'') as specifically designated by the Exchange. The Exchange may 
list $1 strike prices on any other option classes if those classes are 
specifically designated by other securities exchanges that employ a 
similar $1 Pilot under their respective rules.
    To be eligible for inclusion into the $1 Pilot, an underlying stock 
must close below $20 in its primary market on the previous trading day.
    After a stock is added to the $1 Pilot, the Exchange may list $1 
strike prices from $3 to $20 that are no more than $5 from the closing 
price of the underlying on the preceding day. For example, if the 
underlying stock closes at $13, the Exchange may list strike prices 
from $8 to $18.
    The Exchange may not list series with $1 intervals within $0.50 of 
an existing $2.50 strike price (e.g., $12.50, $17.50) in the same 
series. Additionally, the Exchange may not list long-term option series 
(``LEAPS[reg]'') at $1 strike price intervals for any option class 
selected for the $1 Pilot.
    A stock shall remain in the $1 Pilot until otherwise designated by 
the Exchange. The $1 Pilot shall expire on June 5, 2004;
    (ii) $2.50 or greater where the strike price is $25 or less[,]; 
provided, however, that the Exchange may not list $2.50 intervals below 
$20 (e.g., $12.50, $17.50) for any class included within the $1 Pilot 
if the addition of $2.50 intervals would cause the class to have strike 
price intervals that are $0.50 apart;
    (iii) $5[.00] or greater where the strike price is greater than $25 
but less than $200[,]; and
    (iv) $10 or greater where the strike price is $200 or more, except 
as provided in paragraph (b) below.
    The interval of strike prices of series of options on Exchange-
Traded Fund Shares will be $1 or greater where the strike price is 
[less than ]$200 or less.

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 III 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 PHLX proposes to amend PHLX Rule 1012, ``Series of Options Open 
for Trading,'' to implement the Pilot Program, which will operate for a 
pilot period ending on June 5, 2004. The Pilot Program will allow the 
PHLX to list a finite number of options at $1.00 strike price intervals 
pursuant to the Pilot Program. Specifically, the proposal will allow 
the PHLX to originally list as many as five options at $1.00 strike 
price intervals within certain parameters specified in the proposed 
rule, and to multiply list options classes at $1.00 strike price 
intervals where those classes were specifically designated by other 
securities exchanges that employ a similar $1.00 strikes pilot program 
under their rules.
    PHLX Rule 1012 establishes guidelines regarding the addition of 
strike prices for series of options. Currently, the PHLX may list 
options at $2.50 intervals where the strike price is $25.00 or less, at 
$5.00 intervals where the strike price is greater than $25.00 but less 
than $200.00, and at $10.00 intervals when the strike price is $200.00 
or more.\6\ The PHLX notes that over the past two years, prices of 
stocks in general have dropped, with many listings suffering 
precipitous declines. As a result, there has been a proliferation of 
stocks trading below $20.00, and the PHLX lists options on more than 
390 such stocks, including Ford Motor Company, Cisco Systems, Inc., Sun 
Microsystems, Inc., Corning, Inc., Motorola, Inc., Nextel 
Communications, Inc., AOL Time Warner, Inc., and Walt Disney Company. 
According to the PHLX, these stocks trading below $20.00 are among the 
most widely held and actively traded equities listed on the New York 
Stock Exchange, Inc., the American Stock Exchange LLC, and Nasdaq, and 
the options overlying these stocks also trade actively.
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    \6\ See PHLX Rule 1012, Commentary .05. See also PHLX Rule 1012, 
Commentary .05(b), which establishes guidelines for listing $2.50 
strikes for a set number of classes trading between $25.00 and 
$50.00.
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    The PHLX notes that when a stock underlying an option trades at 
lower prices, it requires a larger percentage gain in the price of the 
stock for the option to become in-the-money. For example, when a stock 
trades at $6.00 and a potential investor wants to buy out-of-the-money 
call options, he or she will have to buy the calls at a $7.50 strike 
price. At these pricing levels, the stock would need to achieve a 25% 
price gain before reaching at-the-money status. Such a 25% or higher 
gain in the underlying stock is particularly significant in light of 
the substantially lessened degree of volatility in many stocks and 
options in the past several months. As a result, the PHLX believes that 
there is a disincentive for investors to use options on these lowest-
tier stocks to manage risk. Additionally, with the recent increase in 
the number of stocks trading below $20.00, PHLX member firms have 
expressed a strong desire to list additional strike prices on these 
stocks in order to provide their customers with greater flexibility in 
achieving their investment strategies. The PHLX believes that the 
proposed Pilot Program would give investors an opportunity to more 
closely and effectively tailor their options investments to the price 
of the underlying stock and at the same time would allow the PHLX to 
take advantage of competitive opportunities to list options at $1.00 
strike prices pursuant to the terms of the Pilot Program.
    Moreover, the PHLX believes that implementing the Pilot Program is 
decidedly pro-competitive. The PHLX believes, and has consistently 
maintained, that its ability to list options is a significant, and 
indispensable, component of competition that should not be 
circumscribed. The PHLX believes that it, like the other options 
exchanges, should be able to list $1.00 strike price intervals 
(pursuant to the terms of the Pilot Program) for the issues that it 
believes are commercially feasible or desirable. The PHLX maintains 
that, as history has frequently borne out, yesterday's lowest-
performing options, particularly those in the lowest priced trading 
bracket (i.e., the lowest priced stocks), could well become tomorrow's 
most desirable options.
    For these reasons, the PHLX proposes to implement the Pilot 
Program, as described below.

Options Eligible for the Pilot Program

    The Pilot Program would allow the Exchange to list $1.00 strike 
prices on equity options overlying up to five individual stocks 
provided that the strike prices are $20.00 or less, but not less than 
$3.00. The appropriate Exchange committee will determine which 
underlying stocks will be included in the Pilot Program. A class 
becomes eligible for inclusion in the

[[Page 35935]]

Pilot Program when the underlying stock price closes below $20.00 in 
the primary market on the previous trading day. Underlying stocks 
trading under $20.00 that are not a part of the Pilot Program will 
continue to be eligible for trading at $2.50 and $5.00 intervals.
    Although the PHLX may select up to five securities to be included 
in the Pilot Program, the Exchange would not be precluded from also 
listing options on other stocks at $1.00 strike price intervals if 
other options exchanges list those series pursuant to their respective 
$1.00 strike price pilot programs.
    The Exchange will not list $1.00 strike price intervals on LEAPS 
pursuant to the Pilot Program.

Adding $1.00 Strike Price Intervals

    The procedures for adding $2.50 or $5.00 strikes are contained in 
Exchange Rule 1012, Commentary .05, which will be amended to allow the 
addition of $1.00 strike price intervals.\7\ Under the proposed Pilot 
Program, the closing price of the underlying stock will serve as the 
reference point for determining which $1.00 strike prices the Exchange 
may open for trading.
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    \7\ PHLX Rule 1012(a)(iii) permits the Exchange to add a new 
option series ``as the market price of the underlying stock or 
Exchange-Traded Fund Share or the underlying foreign currency, as 
the case may be, moves substantially from the initial exercise price 
or prices.'' Moreover, PHLX Rule 1010 provides that where 
exceptional circumstances have caused an underlying security not to 
comply with the Exchange's maintenance requirements, ``the Exchange 
may, in the interest of maintaining a fair and orderly market for 
the protection of investors, determine to open additional series of 
option contracts on the class covering that underlying security.''
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    To minimize unnecessary proliferation of series, the PHLX will only 
list $1.00 strike prices within a range of $5.00 greater or $5.00 less 
than the closing price of the underlying stock on the primary market on 
the day before selection by the Exchange. No strike prices will be 
added outside the $5.00 range. For example, if the underlying trades at 
$6.00, the PHLX could list $1.00 strikes from $3.00 to $11.00. The 
Exchange believes that this proposed range-format will significantly 
restrict the number of series that may be added at any one time.
    As noted above, PHLX Rule 1012, Commentary .05, currently allows 
the PHLX to list strike prices with $2.50 intervals when an underlying 
stock trades below $25.00. For this reason, several options have $7.50, 
$12.50, and $17.50 strike price intervals. To further avoid the 
proliferation of series, the PHLX does not intend to list $1.00 strike 
prices at levels that ``bracket,'' that is, are on either side of, 
existing $2.50 intervals (e.g., $7.00 and $8.00 strikes around a $7.50 
strike). Accordingly, in this situation, there must be more than $0.50 
between any two strike prices. Thus, if the underlying stock closed at 
$5.00, the Pilot Program would permit the Exchange to list options with 
$1.00 strike price intervals from $3.00 to $10.00, if nothing was 
trading already at $5.00 and $7.50 strike prices, or $1.00 strike price 
intervals at $3.00, $4.00, $6.00, $9.00 and $10.00, if options were 
already trading at $5.00 and $7.50 strike prices. When the $2.50 
intervals are ``phased-out,'' as described below, the PHLX will 
introduce $1.00 intervals that ``bracket'' the phased-out price. For 
example, when the $7.50 series expires, the PHLX will replace it by 
issuing a new month with $7.00 and $8.00 intervals.

Phasing-Out $2.50 Strike Price Intervals

    Once an option becomes part of the Pilot Program, the Exchange will 
begin the process of phasing-out existing $2.50 intervals overlying the 
same stock in favor of $1.00 intervals. To phase out the $2.50 
intervals, the Exchange initially will delist those $2.50 series for 
which there is no open interest. Subsequently, the Exchange will no 
longer add new expiration months at $2.50 intervals below $20.00 when 
the existing months expire. This process will effectively phase-out the 
remaining $2.50 intervals as the farthest-out months expire.

Adding Expiration Months

    PHLX Rule 1012 generally allows the Exchange to make available for 
trading four expiration months for each initial listing of an option. 
Upon expiration of the near-term month, the Exchange may list an 
additional expiration month. Under the Pilot Program, if the underlying 
closed at or above $20.00 on Expiration Friday, the PHLX would not list 
an additional month for a $1.00 strike series until the stock again 
closed below $20.00 in the primary market on the day before selection 
for listing.

Deleting $1.00 Strike Price Intervals

    At any time, the Exchange may cease listing $1.00 strike prices on 
existing series by submitting a Cessation Notice to the Options 
Clearing Corporation (``OCC'').\8\ As discussed above, if the 
underlying closed at or above $20.00 on Expiration Friday, the Exchange 
would not list any additional months with $1.00 strike prices until the 
stock subsequently closed below $20.00 on the primary market on the day 
prior to the Exchange listing the option. If the underlying stock does 
not subsequently close below $20.00, thereby precluding the listing of 
additional $1.00 strike prices and months, the existing $1.00 series 
would eventually expire. When the near-term month is the only series 
available for trading in the Pilot Program, the Exchange may submit a 
Cessation Notice to OCC. Upon submission of that notice, the listing 
would no longer count towards the five listings that are allowed the 
Exchange pursuant to the Pilot Program, thereby allowing the PHLX to 
list classes on an additional stock. Once the Exchange submits the 
Cessation Notice, it would not list any additional months for trading 
with strikes below $20.00 within the Pilot Program unless the 
underlying once closed below $20.00, as required by the Pilot 
Program.\9\
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    \8\ The reasons for submitting a Cessation Notice include: 
expiration of available $1.00 strikes (i.e., the underlying stock 
price on the primary market remains above $20.00); series 
proliferation concerns; and delisting because of, among other 
things, low price, merger, or takeover. In any event, the PHLX would 
continue to have the ability to cease trading series that become 
inactive and have no open interest, with prior notice to its 
members).
    \9\ If the underlying stock trades below $20.00 after submission 
of the Cessation Notice by the PHLX, the Exchange could list $1.00 
strike prices again provided it included the class as one of the 
five classes permitted under the Pilot Program.
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Options Price Reporting Authority (``OPRA'') Capacity

    The Exchange believes that, according to OPRA figures, there is 
sufficient capacity to accommodate the Exchange's proposed Pilot 
Program. The PHLX believes that there is significant excess system 
capacity at this time: on a daily basis, the options exchanges are 
using an average of less than 7,000 messages per second (``mps'') 
during peak periods, which is less than 25% of the total system 
capacity of 32,000 mps.\10\ To date, the exchanges have yet to exceed 
11,000 mps for any extended period of time.\11\ Thus, the PHLX believes 
that implementing the Pilot Program should not have any significant 
negative impact on OPRA system capacity.
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    \10\ Securities Industry Automation Corporation (``SIAC''), 
which administers and services the network for OPRA, estimates that 
as much as 6,000 mps of the total system capacity will be used to 
send best bid and offer (``BBO'') messages when the BBO feed becomes 
operational. See Securities Exchange Act Release No. 47231 (January 
22, 2003), 68 FR 4258 (January 28, 2003) (publication of notice of 
File No. SR-OPRA-2002-01). See also Securities Exchange Act Release 
No. 47231 (January 22, 2003), 68 FR 4258 (January 28, 2003) (order 
approving File No. SR-OPRA-2002-01).
    \11\ On November 6, 2002, the OPRA five-minute message peak was 
8,203 mps. On November 13, 2002, the one-minute peak was 10,091 mps.

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[[Page 35936]]

2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
section 6(b)\12\ of the Act in general and furthers the objectives of 
section 6(b)(5),\13\ in particular, in that it is designed to perfect 
the mechanism of a free and open market and a national market system, 
protect investors and the public interest and promote just and 
equitable principles of trade. According to the PHLX, the proposal 
would achieve this by allowing the listing of $1 strike price 
intervals, thereby stimulating customer interest in options overlying 
the lowest tier of stocks and creating greater trading opportunities 
and flexibility and providing customers with the ability to more 
closely tailor investment strategies to the precise movement of the 
underlying stocks.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The PHLX does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants, or Others No written 
comments were solicited or received.

III. 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 
filings will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No. SR-PHLX-2002-55 and should be submitted by July 8, 2003.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\14\ In particular, the Commission believes that the proposed 
rule change is consistent with section 6(b)(5) of the Act,\15\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and, in 
general, to protect investors and the public interest. Specifically, 
the Commission believes that the proposed listing of one point strike 
price intervals in selected equity options on a pilot basis should 
provide investors with more flexibility in the trading of equity 
options overlying stocks trading at more than $3 but less than $20, 
thereby furthering the public interest by allowing investors to 
establish equity options positions that are better tailored to meet 
their investment objectives. The Commission also believes that the 
Exchange's limited Pilot Program strikes a reasonable balance between 
the Exchange's desire to accommodate market participants by offering a 
wide array of investment opportunities and the need to avoid 
unnecessary proliferation of options series. The Commission expects the 
Exchange to monitor the applicable equity options activity closely to 
detect any proliferation of illiquid options series resulting from the 
narrower strike price intervals and to act promptly to remedy this 
situation should it occur. In addition, the Commission requests that 
the PHLX monitor the trading volume associated with the additional 
options series listed as a result of the Pilot Program and the effect 
of these additional series on market fragmentation and on the capacity 
of the Exchange's, OPRA's, and vendors' automated systems.
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    \14\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \15\ 15 U.S.C. 78f(b)(5).
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    As noted above, the Commission is approving the PHLX's proposal on 
a pilot basis. In the event that PHLX proposes to extend the Pilot 
Program beyond June 5, 2004, expand the number of options eligible for 
inclusion in the Pilot Program, or seek permanent approval of the Pilot 
Program, it should submit a Pilot Program report to the Commission 
along with the filing of such proposal.\16\ The report must cover the 
entire time the Pilot Program was in effect, and must include: (1) Data 
and written analysis on the open interest and trading volume for 
options (at all strike price intervals) selected for the Pilot Program; 
(2) delisted options series (for all strike price intervals) for all 
options selected for the Pilot Program; (3) an assessment of the 
appropriateness of $1 strike price intervals for the options the PHLX 
selected for the Pilot Program; (4) an assessment of the impact of the 
Pilot Program on the capacity of the PHLX's, OPRA's, and vendors' 
automated systems; (5) any capacity problems or other problems that 
arose during the operation of the Pilot Program and how the PHLX 
addressed them; (6) any complaints that the PHLX received during the 
operation of the Pilot Program and how the PHLX addressed them; and (7) 
any additional information that would help to assess the operation of 
the Pilot Program.
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    \16\ The Commission expects the PHLX to submit a proposed rule 
change at least 60 days before the expiration of the Pilot Program 
in the event the PHLX wishes to extend, expand, or seek permanent 
approval of the Pilot Program.
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    The Commission finds good cause for approving the proposal prior to 
the thirtieth day after the date of publication of notice of filing 
thereof in the Federal Register. The PHLX's Pilot Program is identical 
to a CBOE pilot program (``CBOE Pilot'') that the Commission 
approved.\17\ Notice of the CBOE Pilot was published for comment \18\ 
and the Commission received one comment letter, which supported the 
CBOE's proposal. Accordingly, the Commission believes that the proposal 
raises no issues of regulatory concern and that there is good cause, 
consistent with sections 6(b)(5) and 19(b) of the Act,\19\ to approve 
the PHLX's proposal on an accelerated basis.
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    \17\ See Securities Exchange Act Release No. 47991 (June 5, 
2003) (order approving File No. SR-CBOE-2001-60).
    \18\ See Securities Exchange Act Release No. 47753 (April 29, 
2003), 68 FR 23784 (May 5, 2003).
    \19\ 15 U.S.C. 78f(b)(5) and 78s(b).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-PHLX-2002-55) and Amendment 
Nos. 1, 2, and 3 thereto are hereby approved, on an accelerated basis 
and as a pilot program, through June 5, 2004.
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    \20\ 15 U.S.C. 78s(b)(2).


[[Page 35937]]


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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-15263 Filed 6-16-03; 8:45 am]
BILLING CODE 8010-01-P