[Federal Register Volume 69, Number 175 (Friday, September 10, 2004)]
[Notices]
[Pages 54818-54821]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2143]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50311]


Order Granting Application for a Temporary Conditional Exemption 
Pursuant To Section 36(a) of the Exchange Act by the National 
Association of Securities Dealers, Inc. Relating to the Acquisition of 
an ECN by The Nasdaq Stock Market, Inc.

September 3, 2004.

I. Introduction

    The National Association of Securities Dealers, Inc. (``NASD''), 
through its subsidiary, The Nasdaq Stock Market, Inc. (``Nasdaq''), 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to Rule 0-12 \1\ under the Securities Exchange Act of 1934 
(``Exchange Act''), an application for an exemption under Section 
36(a)(1) of the Exchange Act \2\ from the rule filing requirements of 
Section 19(b) of the Exchange Act \3\ with respect to Nasdaq's 
acquisition of Brut, LLC, operator of the Brut ECN (``Brut''), a 
registered broker-dealer, and electronic communications network 
(``ECN''), as a wholly-owned subsidiary of Nasdaq.\4\ This order 
temporarily grants the request for exemptive relief subject to NASD and 
Nasdaq satisfying certain conditions, which are outlined below.
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    \1\ 17 CFR 240.0-12.
    \2\ 15 U.S.C. 78mm(a)(1).
    \3\ 15 U.S.C. 78s(b).
    \4\ On August 6, 2004, the NASD Board of Governors approved 
Nasdaq's proposal to seek the exemption. The obligation to file with 
the Commission proposed changes to the NASD rules concerning Nasdaq 
systems has been delegated to Nasdaq by the NASD, pursuant to the 
Plan of Allocation and Delegation of Functions by NASD to 
Subsidiaries (``Delegation Plan''). Nasdaq submitted this request 
for exemption pursuant to the Delegation Plan.
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II. Nasdaq's Application for Temporary Conditional Exemption From 
Section 19(b) Rule Filing Requirements

    On August 25, 2004, Nasdaq requested that the Commission grant 
temporary exemptive relief, subject to certain conditions, from the 
rule filing procedures of Section 19(b) of the Exchange Act \5\ with 
regard to Nasdaq's acquisition and operation of Brut as a wholly-owned 
subsidiary of Nasdaq.\6\ According to Nasdaq's Exemption Request, 
Nasdaq entered into a definitive agreement to purchase Brut on May 25, 
2004. Brut is currently an NASD member and participates in the Nasdaq 
Market Center execution system (formerly know as the ``Nasdaq National 
Market Execution System'' or ``SuperMontage'') as a Nasdaq Order-
Delivery ECN.\7\ Brut's current relationship with Nasdaq is limited to 
participating in the Nasdaq Market Center execution system in the same 
manner as other ECNs. Nasdaq currently has no ownership interest in 
Brut.\8\
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    \5\ Id.
    \6\ See letter from Edward S. Knight, Executive Vice President 
and General Counsel, Nasdaq, to Jonathan G. Katz, Secretary, 
Commission, dated August 25, 2004 (``Exemption Request'').
    \7\ See NASD Rule 4701(t).
    \8\ See Exemption Request, supra note 6.
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    Once acquired by Nasdaq, Brut would become a ``facility'' of a 
self-regulatory organization (``SRO'') pursuant to

[[Page 54819]]

Section 3(a)(2) of the Exchange Act \9\ because Brut would be property 
of Nasdaq used for the purpose of effecting or reporting securities 
transactions.\10\ As a result, NASD and, pursuant to the Delegation 
Plan, Nasdaq would be obligated, under Section 19(b) of the Exchange 
Act \11\ to file with the Commission proposed rules governing the 
operation of Brut's trading system and subscriber fees.
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    \9\ See 15 U.S.C. 78c3(a)(2).
    \10\ See Exemption Request, supra note 6. See also, supra note 
9.
    \11\ 15 U.S.C. 78s(b).
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    Until transfer of ownership, Nasdaq and Brut remain legally 
separate entities, each of which, among other things, are engaged in 
and competing for, the business of facilitating securities 
transactions. Because Nasdaq and Brut are competitors, Nasdaq 
represents that it and Brut are limited in the amount and type of 
information that can be exchanged between them prior to the 
acquisition's consummation (e.g., information about the technical 
specifications of Brut's execution algorithm, order types, and 
pricing).\12\ Nasdaq represents that this information from Brut is a 
necessary and important component of any rule filing it may submit to 
the Commission related to Brut and that this information must be kept 
confidential by Brut, and cannot be shared with Nasdaq, prior to the 
closing of the transaction. Moreover, Nasdaq stated in its Exemption 
Request that without such information, it would be unable to prepare 
and submit rule filings regarding Brut's operation and fee structure 
prior to close of the transaction and the transfer of ownership of Brut 
to Nasdaq. In its Exemption Request, Nasdaq represented that upon 
assuming ownership of Brut, Nasdaq and Brut would be relieved of 
certain legal constraints in sharing information and would begin to 
share the previously restricted information so that, among other 
things, Nasdaq could draft rules governing Brut's functionality and 
fees (``Brut Filings'').
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    \12\ Nasdaq represents that, as legally distinct entities, the 
exchange of sensitive information between Nasdaq and Brut pre-
closing would subject them to Section 1 of the Sherman Antitrust 
Act, 15 U.S.C. 1, as well as to the ``gun jumping'' provisions of 
the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as 
amended, 15 U.S.C. 18a. See Section 1 of the Sherman Antitrust Act, 
15 U.S.C. 1; Hart-Scott-Rodino Antitrust Improvements Act of 1976, 
15 U.S.C. 18a. See Exemption Request, supra note 6.
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    In its Exemption Request, Nasdaq asserted that without Commission 
approval of rules governing Brut's operation, it would not be able to 
operate Brut, thereby causing Brut to cease operations until the Brut 
Filings were approved by the Commission. Because Brut presently 
accounts for a significant portion of the share volume for Nasdaq-
listed securities, the summary termination of its services could 
potentially harm investors and disrupt the functioning of a fair and 
orderly market. The requested exemption would allow Brut to continue to 
operate, subject to certain conditions, after it is acquired by Nasdaq, 
while NASD and Nasdaq undertake to comply with the procedures related 
to rule changes under Section 19(b) of the Exchange Act.\13\ In 
addition, Nasdaq asserted that the requested exemption would be 
consistent with the protection of investors and the public interest, 
because it would allow Brut to continue to operate its ECN trading 
system during the period immediately after its purchase by Nasdaq.
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    \13\ 15 U.S.C. 78s(b).
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    The exemption would also provide Nasdaq a reasonable opportunity to 
fully analyze Brut's systems, operations, and fee structure to ensure 
an orderly integration of Brut and Nasdaq and to make accurate filings 
based on such information. In addition, Nasdaq stated that the 
exemption would not diminish the Commission's ability to monitor Nasdaq 
and Brut. In this regard, Nasdaq noted that to the extent it would 
undertake to make changes to its non-Brut systems during the exemption 
period, or thereafter, NASD and Nasdaq would remain subject to Section 
19(b) and thus obligated to file proposed rule changes with the 
Commission. Further, in its Exemption Request, NASD and Nasdaq 
committed to satisfying certain conditions, which are outlined below. 
For example, as a condition to the exemption, Nasdaq would be required 
to submit proposed rule changes with respect to any material changes to 
Brut's functions during the exemption period. In this regard, Nasdaq 
noted in its Exemption Request that it currently anticipates making no 
material changes to Brut's ECN functionality during the exemption 
period.\14\
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    \14\ If such changes become necessary as the result of continued 
competition, however, Nasdaq's commitment above to file proposed 
rule changes would provide the Commission the opportunity to review 
any such modifications. See Exemption Request, supra note 6.
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III. Order Granting Temporary Conditional Section 36 Exemption

    In 1996, Congress gave the Commission greater flexibility to 
regulate trading systems, such as Brut, by granting the Commission 
broad authority to exempt any person from any of the provisions of the 
Exchange Act and to impose appropriate conditions on their 
operation.\15\ Specifically, NSMIA added Section 36(a)(1) to the 
Exchange Act, which provides that ``the Commission, by rule, 
regulation, or order, may conditionally or unconditionally exempt any 
person, security, or transaction, or any class or classes of persons, 
securities, or transactions, from any provision or provisions of [the 
Exchange Act] or of any rule or regulation thereunder, to the extent 
that such exemption is necessary or appropriate in the public interest, 
and is consistent with the protection of investors.'' \16\ In enacting 
Section 36, Congress indicated that it expected that ``the Commission 
will use this authority to promote efficiency, competition and capital 
formation.'' \17\ It particularly intended to give the Commission 
sufficient flexibility to respond to changing market and competitive 
conditions:
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    \15\ 15 U.S.C. 78mm(a). Section 36 of the Exchange Act was 
enacted as part of the National Securities Markets Improvements Act 
1996, Pub. L. 104-290 (``NSMIA'').
    \16\ 15 U.S.C. 78mm(a).
    \17\ H.R. Rep. No. 104-622, 104th Cong., 2d Sess. 38 (1996).
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    The Committee recognizes that the rapidly changing marketplace 
dictates that effective regulation requires a certain amount of 
flexibility. Accordingly, the bill grants the SEC general exemptive 
authority under both the Securities Act and the Securities Exchange 
Act. This exemptive authority will allow the Commission the 
flexibility to explore and adopt new approaches to registration and 
disclosure. It will also enable the Commission to address issues 
relating to the securities markets more generally. For example, the 
SEC could deal with the regulatory concerns raised by the recent 
proliferation of electronic trading systems, which do not fit neatly 
into the existing regulatory framework.\18\
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    \18\ S. Rep. No. 104-293, 104th Cong., 2d Sess. 15 (1996).

    In recent years, the Commission has exercised its Section 36 
exemptive authority to enhance competition as a means to meet the 
objectives of the Exchange Act.\19\
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    \19\ 15 U.S.C. 78mm. For example, the Commission issued an order 
pursuant to Section 36 of the Exchange Act, granting NASD a 
temporary exemption from Section 19(b), relating to the acquisition 
and operation by Nasdaq of a software development company. See 
Securities Exchange Act Release No. 42713 (April 24, 2000), 65 FR 
25401 (May 1, 2000). See also Securities Exchange Act Release No. 
49260 (February 17, 2004), 69 FR 8500 (February 24, 2004) (Order 
Granting Application for Exemptions Pursuant to Section 36(a) of the 
Exchange Act by the American Stock Exchange LLC, the International 
Securities Exchange, Inc., the Municipal Securities Rulemaking 
Board, the Pacific Exchange, Inc., the Philadelphia Stock Exchange, 
Inc., and the Boston Stock Exchange, Inc.).
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    Section 19(b)(1) of the Exchange Act requires an SRO, including 
NASD, to

[[Page 54820]]

file with the Commission its proposed rule changes accompanied by a 
concise general statement of the basis and purpose of the proposed rule 
change.\20\ Once a proposed rule change has been filed with the 
Commission, the Commission is required to publish notice of it and 
provide an opportunity for public comment. The proposed rule change may 
not take effect unless approved by the Commission by order, unless the 
rule change is within the class of rule changes that are effective upon 
filing pursuant to Section 19(b)(3)(A) of the Act.\21\
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    \20\ 15 U.S.C. 78s(b)(1). This obligation also applies to 
Nasdaq, because Nasdaq has been delegated specific responsibilities 
related to rule changes affecting Nasdaq filed with the Commission 
pursuant to the Delegation Plan. See also, supra note 4.
    \21\ 15 U.S.C. 78s(b)(3)(A).
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    Section 19(b)(1) of the Exchange Act \22\ defines the term 
``proposed rule change'' to mean ``any proposed rule or rule change in, 
addition to, or deletion from the rules of [a] self-regulatory 
organization.'' Pursuant to Section 3(a)(27) and 3(a)(28) of the 
Exchange Act, the term ``rules of a self-regulatory organization'' 
means (1) the constitution, articles of incorporation, bylaws and 
rules, or instruments corresponding to the foregoing, of an SRO, and 
(2) such stated policies, practices and interpretations of an SRO 
(other than the MSRB) as the Commission, by rule, may determine to be 
necessary or appropriate in the public interest or for the protection 
of investors to be deemed to be rules. Rule 19b-4(b) under the Exchange 
Act,\23\ defines the term ``stated policy, practice, or 
interpretation'' to mean generally ``any material aspect of the 
operation of the facilities of the self-regulatory organization \24\ or 
any statement made available to the membership, participants, or 
specified persons thereof that establishes or changes any standard, 
limit, or guideline with respect to rights and obligations of specified 
persons or the meaning, administration, or enforcement of an existing 
rule.''
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    \22\ 15 U.S.C. 78s(b)(1).
    \23\ 17 CFR 240.19b-4.
    \24\ The term ``facilities of the self-regulatory organization'' 
is not defined in the Exchange Act. The Commission, however, has 
found that Nasdaq generally performs the functions commonly 
performed by an exchange. See Securities Exchange Act Release No. 
40760 (December 8, 1998), 63 FR 70844 (December 22, 1998) at nn. 58-
61 and accompanying text.
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    The term ``facility'' is defined in Section 3(a)(2) of the Exchange 
Act, with respect to an exchange, to include ``its premises, tangible 
or intangible property whether on the premises or not, any right to use 
such premises or property or any service thereof for the purpose of 
effecting or reporting a transaction on an exchange (including, among 
other things, any system of communication to or from the exchange, by 
ticker or otherwise, maintained by or with the consent of the 
exchange), and any right of the exchange to the use of any property or 
service.''
    In its Exemption Request, Nasdaq acknowledges that upon closing of 
the purchase transaction, Brut would become a facility of Nasdaq 
because the Brut trading system would be property of Nasdaq that is 
used for the purpose of effecting or reporting securities transactions. 
Section 19(b) of the Exchange Act and Rule 19b-4 thereunder, absent an 
exemption, would require NASD to file proposed rules with the 
Commission to allow Nasdaq to operate Brut as a facility. Further, 
Nasdaq represented in its Exemption Request that, due to legal 
constraints regarding information sharing, it would be unable to submit 
the Brut filings prior to close of the transaction and the transfer of 
ownership of Brut to Nasdaq. In its Exemption Request, Nasdaq 
represented that upon assuming ownership of Brut, Nasdaq and Brut would 
be permitted to share information so that Nasdaq could undertake to 
prepare and submit the Brut Filings in compliance with NASD's 
obligations under Section 19(b) of the Exchange Act and Rule 19b-4 
thereunder.\25\
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    \25\ See Exemption Request, supra note 6.
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    The Commission believes that it is appropriate to issue an 
exemption, subject to the conditions described below, to allow Nasdaq 
to operate Brut as a facility without being subject to the rule filing 
requirements of Section 19(b) of the Exchange Act for a temporary 
period. Accordingly, the Commission has determined to grant Nasdaq's 
request for an exemption, subject to certain conditions, not to exceed 
six months from the date Nasdaq acquires ownership of Brut. The 
Commission finds that the temporary conditional exemption from the 
provisions of Section 19(b) of the Exchange Act \26\ is necessary and 
appropriate in the public interest and is consistent with the 
protection of investors. In particular, the Commission believes that 
this exemption provides a limited amount of time for NASD and Nasdaq to 
obtain the necessary information to undertake to comply with NASD's 
obligations under Section 19(b) of the Exchange Act relative to 
Nasdaq's acquisition of Brut. In addition, the Commission believes that 
the exemption should help promote efficiency and competition in the 
market by allowing Brut to continue to operate while the Brut filings 
are pending before the Commission. In this regard, the Commission 
believes that this exemption should help to avoid any potential 
negative consequences to investors that could result if Nasdaq was 
required to abruptly limit Brut's trading operations immediately upon 
consummation of its acquisition of Brut.
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    \26\ 26 15 U.S.C. 78s(b).
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    To provide the Commission the opportunity to review and act upon 
any proposal to change Brut's fees or to make material changes to 
Brut's operations as an ECN during the period covered by the exemption, 
as well as to ensure that the Commission's ability to monitor Nasdaq 
and Brut is not diminished by the exemption, the Commission is imposing 
the following conditions while the exemption is in effect.\27\ The 
Commission believes such conditions are necessary and appropriate in 
the public interest for the protection of investors. Therefore, the 
Commission is granting to NASD a temporary exemption, pursuant to 
Section 36 of the Exchange Act, from the rule filing requirements 
imposed by Section 19(b) of the Exchange Act as set forth above 
provided that NASD and Nasdaq comply with the following conditions:
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    \27\ See Exemption Request, supra note 6.
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    (1) Brut remains a registered broker-dealer under Section 15 of the 
Exchange Act and continues to operate as an ECN;
    (2) Brut operates in compliance with the obligations set forth 
under Regulation ATS;
    (3) Brut operates as a separate subsidiary of Nasdaq;
    (4) Nasdaq files a proposed rule change under Section 19 of the 
Exchange Act if it seeks to make a material change to Brut's 
operations. A material change would include any changes to a stated 
policy, practice, or interpretation regarding the operation of Brut or 
any other event or action relating to Brut that would require the 
filing of a proposed rule change by an SRO or an SRO facility; \28\
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    \28\ See Section 19(b) of the Exchange Act and Rule 19b-4 
thereunder. The Commission notes that a material change would 
include, among other things, changes to Brut's operating platform; 
the types of securities traded on Brut; Brut's types of subscribers; 
or the reporting venue for trading that takes place on Brut. The 
Commission also notes that the rule filings must set forth the 
operation of the Brut facility and its integration with Nasdaq 
sufficiently so that the Commission and the public can evaluate the 
proposed change.
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    (5) Nasdaq files a proposed rule change under Section 19 of the 
Exchange Act \29\ if it seeks to modify Brut's fee schedule;
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    \29\ 15 U.S.C. 78s(b).

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    (6) Nasdaq treats Brut the same as other ECNs that participate in 
the Nasdaq Market Center, and, in particular, Nasdaq does not accord 
Brut preferential treatment in how Brut submits orders to the Nasdaq 
Market Center execution system or in the way its orders are displayed 
or executed; and
    (7) Nasdaq submits rule filings under Section 19(b) of the Exchange 
Act \30\ fully articulating its operation of Brut and Brut's 
integration with Nasdaq within sixty days of the date Nasdaq assumes 
ownership of Brut.\31\
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    \30\ 15 U.S.C. 78s(b).
    \31\ See Exemption Request, supra note 6.
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    In addition, the Commission notes that NASD is currently the 
Designated Examining Authority (``DEA'') for Brut. On August 6, Nasdaq 
applied for membership to the New York Stock Exchange (``NYSE'') on 
behalf of Brut. In its Exemption Request, Nasdaq commits to seek the 
Commission's approval pursuant to Rule 17d-1 under the Exchange Act 
\32\ to have the NYSE appointed as Brut's DEA for financial 
responsibility rules upon approval of Brut's membership in the NYSE.
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    \32\ 17 CFR 240.17d-1.
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    In granting the Commission broad exemptive authority in Section 36 
of the Exchange Act,\33\ Congress intended to incorporate flexibility 
into the Exchange Act's regulatory scheme to reflect a rapidly changing 
marketplace. Congress particularly intended for the Commission to use 
this flexibility to promote efficiency and competition. The Commission 
believes that the requested temporary conditional exemption will help 
achieve these goals, while upholding the regulatory objectives of the 
Exchange Act. In granting this relief, the Commission makes no finding 
regarding whether Nasdaq's operation of Brut as a facility would be 
consistent with the Exchange Act. Proposed rule changes regarding 
Nasdsaq's operation of Brut will be evaluated by the Commission in 
accordance with the procedures set forth under Section 19(b) of the 
Exchange Act.\34\
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    \33\ 15 U.S.C. 78mm(a).
    \34\ See supra notes 20-23.
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    The Commission notes that without its approval of rules governing 
the operation of Brut, Nasdaq would be unable to operate Brut, thereby 
causing Brut to cease operations until the Brut Filings are approved by 
the Commission. Should Brut be required to abruptly cease operations, a 
significant source of liquidity would be lost, which could potentially 
disrupt the functioning of an orderly market and harm investors. This 
exemptive relief should facilitate competition in the market by 
allowing Brut to continue to provide liquidity and compete with other 
market centers, while also providing NASD and Nasdaq with a reasonable 
opportunity to comply with their obligations under Section 19(b) of the 
Exchange Act. Therefore, the Commission believes that this exemption 
strikes an appropriate balance between the Commission's interest to 
encourage competition in the rapidly changing market place and to 
uphold the procedural requirements under Section 19(b) of the Exchange 
Act, and thus is necessary and appropriate in the public interest and 
is consistent with the protection of investors.
    For the reasons discussed above, the Commission finds that the 
temporary conditional exemptive relief requested by NASD and Nasdaq is 
necessary and appropriate in the public interest and is consistent with 
the protection of investors.
    It is ordered, pursuant to Section 36 of the Exchange Act,\35\ that 
the application for a temporary conditional exemption is granted for a 
period of six months following Nasdaq's acquisition of Brut.
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    \35\ 15 U.S.C. 78mm.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
 [FR Doc. E4-2143 Filed 9-9-04; 8:45 am]
BILLING CODE 8010-01-P