[Federal Register Volume 69, Number 237 (Friday, December 10, 2004)]
[Notices]
[Pages 71860-71863]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3594]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50788; File No. SR-Phlx-2004-57]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change and Amendments 
No. 1, 2, 3, and 4 Thereto by the Philadelphia Stock Exchange, Inc. 
Relating to the Trade Allocation Algorithm Applicable to Options Traded 
on the Exchange's Electronic Trading Platform, Phlx XL

December 3, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\, and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on August 16, 2004, the Philadelphia Stock Exchange, Inc. 
(``Phlx'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
items I and II, below, which items have been prepared by the Exchange. 
On October 8, 2004, the Exchange filed Amendment No. 1 to the proposed 
rule change.\3\ On October 20, 2004, the Exchange filed Amendment No. 2 
to the proposed rule change.\4\ On November 3, 2004, the Exchange filed 
Amendment No. 3 to the proposed rule change.\5\ Finally, on December 2, 
2004, the Exchange filed Amendment No. 4 to the proposed rule 
change.\6\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons and is 
approving the proposed rule change on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Richard S. Rudolph, Counsel, Phlx, to Marc 
F. McKayle, Special Counsel, Division of Market Regulation 
(``Division''), Commission, dated October 7, 2004 (``Amendment No. 
1''). In Amendment No. 1, Phlx amended the proposed rule change to: 
(1) Clarify that a Phlx XL Participant would be entitled to receive 
an allocation of a number of contracts only up to its disseminated 
size; (2) clarify that options subject to the Enhanced Specialist 
Participation are described in Phlx Rules 1014(g)(ii)-(iv); (3) 
clarify that the proposed rule would apply only to electronically 
executed and allocated Streaming Quote Options that trade on Phlx 
XL; and (4) make technical amendments to the presentation of the 
allocation algorithm described in proposed Phlx Rule 
1014(g)(vii)(B)(1)(b).
    \4\ See letter from Richard S. Rudolph, Counsel, Phlx, to Molly 
M. Kim, Attorney, Division, dated October 20, 2004 (``Amendment No. 
2''). In Amendment No. 2, Phlx amended the proposed rule change to 
correct a typographical error in the numbering of the proposed rule 
text.
    \5\ See letter from Richard S. Rudolph, Counsel, Phlx, to 
Deborah Lassman Flynn, Assistant Director, Division, Commission, 
dated November 2, 2004 (``Amendment No. 3''). In Amendment No. 3, 
Phlx amended the proposed rule change to: (1) Delete the phrase ``if 
the specialist is quoting at the Exchange's disseminated price'' 
from Rule 1014(g)(vii)(B)(1); (2) delete current Rule 
1014(g)(vii)(B)(2); and (3) clarify the definition of ``Phlx XL 
Participant'' to include the specialist, an SQT or a non-SQT ROT 
that has placed a limit order on the limit order book.
    \6\ See Amendment No. 4 from Richard S. Rudolph, Counsel, Phlx, 
dated December 2, 2004 (``Amendment No. 4''). In Amendment No. 4, 
Phlx amended the proposed rule change to clarify that, if 
specialists are not quoting at the Exchange's disseminated price, 
orders for 5 contracts or fewer will be allocated to Phlx XL 
Participants on parity.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Phlx proposes to adopt a new trade allocation algorithm for trades 
executed electronically on the Exchange's electronic options trading 
platform, Phlx XL. Brackets indicate deletions; italics indicate new 
text:
* * * * *
Obligations and Restrictions Applicable to Specialists and Registered 
Options Traders
    Rule 1014. (a)-(f) No change.
    (g)(i)-(vi) No change.
    (vii) Allocation of Automatically Executed Trades in Streaming 
Quote Options. Solely with respect to Streaming Quote Options approved 
by the Exchange to be traded on Phlx XL by Streaming Quote Traders 
(``SQTs'') pursuant to Exchange Rule 1080(k), after public customer 
market and marketable limit orders have been executed, trades 
automatically executed in such options shall be allocated automatically 
in the following manner:
    (A) If [one] the specialist, an SQT or a non-SQT ROT that has 
placed a limit order on the limit order book (``Phlx XL 
[p]Participant'') is quoting alone at the disseminated price and their 
quote is not matched by another Phlx XL participant prior to execution, 
such Phlx XL [p]Participant shall be entitled to receive a number of 
contracts up to the size associated with his/her quotation.
    (B) Parity. Quotations entered electronically by the specialist or 
an SQT that do not cause an order resting on the limit order book to 
become due for execution may be matched at any time by quotations 
entered electronically by the specialist and/or other SQTs, and by ROT 
limit orders entered via electronic interface and shall be deemed to be 
on parity, subject to the requirement that orders of controlled 
accounts must yield priority to customer orders as set forth in Rule 
1014(g)(i)(A).
    (1) [if the specialist is quoting at the Exchange's disseminated 
price:]
    (a) Orders for 5 contracts or fewer shall be allocated first to the 
specialist, provided, however, that on a quarterly basis, the Exchange 
will evaluate what

[[Page 71861]]

percentage of the volume executed on the Exchange is comprised of 
orders for 5 contracts or fewer allocated to specialists, and will 
reduce the size of the orders included in this provision if such 
percentage is over 25%. In order to be entitled to receive the 5 
contract or fewer order preference set forth in this sub-paragraph 
(B)(1)(a), the specialist must be quoting at the Exchange's 
disseminated price, and shall not be entitled to receive a number of 
contracts that is greater than the size that is associated with its 
quote. If the specialist is not quoting at the Exchange's disseminated 
price at the time of execution, orders for 5 contracts or fewer shall 
be allocated to Phlx XL Participants on parity as set forth in 
paragraph (b) below.
    (b) Respecting orders for greater than 5 contracts (regardless of 
whether the specialist is quoting at the Exchange's disseminated 
price), or orders for 5 contracts or fewer when the specialist is not 
quoting at the Exchange's disseminated price, inbound electronic orders 
shall be allocated pursuant to the following allocation algorithm:

[, the specialist shall be entitled to receive a number of contracts 
that is the greater of: (i) The proportion of the aggregate size 
associated with the specialist's quote, SQT quotes, and non-SQT ROT 
limit orders entered on the book via electronic interface at the 
disseminated price represented by the size of the specialist's quote, 
or (ii) 60% of the contracts to be allocated if the specialist is on 
parity with one SQT or one non-SQT ROT that has placed a limit order on 
the book via electronic interface at the Exchange's disseminated price; 
(iii) 40% of the contracts to be allocated if the specialist is on 
parity with two SQTs or non-SQT ROTs that have placed a limit order on 
the book via electronic interface at the Exchange's disseminated price; 
and (iv) 30% of the contracts to be allocated if the specialist is on 
parity with three or more SQTs or non-SQT ROTs that have placed a limit 
order on the book via electronic interface at the Exchange's 
disseminated price. In order to be entitled to receive the number of 
contracts set forth in this sub-paragraph (B)(1)(b), the specialist 
must be quoting at the Exchange's disseminated price, and shall not be 
entitled to receive a number of contracts that is greater than the size 
that is associated with its quote.
    (c) Thereafter, SQTs quoting at the disseminated price and non-SQT 
ROTs that have placed limit orders on the limit order book via 
electronic interface at the Exchange's disseminated price shall be 
entitled to receive a number of contracts that is the proportion of the 
total remaining aggregate size associated with SQT quotes and non-SQT 
ROT limit orders on the book entered via electronic interface at the 
disseminated price represented by the size of the SQT's quote or, in 
the case of a non-SQT ROT, by the size of the limit order they have 
placed on the limit order book via electronic interface. Such SQT(s) 
and non-SQT ROTs shall not be entitled to receive a number of contracts 
that is greater than the size associated with their quotation or limit 
order.]

Equal percentage based on the number of Phlx XL Participants quoting or 
with limit orders at BBO (Component A) + Pro rata percentage based on 
size of Phlx XL participant quotes/limit orders (Component B) x 
Incoming Order Size

2

    Where:
    Component A: The percentage to be used for Component A shall be an 
equal percentage, derived by dividing 100 by the number of Phlx XL 
participants quoting at the BBO.
    Component B: Size Pro Rata Allocation. The percentage to be used 
for Component B of the allocation algorithm formula is that percentage 
that the size of each Phlx XL Participant's quote at the best price 
represents relative to the total number of contracts in the 
disseminated quote.
    Final Weighting: The final weighting formula for equity options, 
which shall be determined by a three-member special committee of the 
Board of Governors, chaired by the Chairman of the Board, and including 
the Chairman of the Options Committee and one on-floor Governor (the 
``Special Committee''), and apply uniformly across all equity options, 
shall be a weighted average of the percentages derived for Components A 
and B multiplied by the size of the incoming order. Initially, the 
weighting of components A and B shall be equal, represented 
mathematically by the formula: (Component A Percentage + Component B 
Percentage)/2) * incoming order size.
    The final weighting formula for index options and options on 
Exchange Traded Fund Shares (as defined in Rule 1000(b)(42.) shall be 
established by the Special Committee and may vary by product. Changes 
made to the percentage weightings of Components A and B shall be 
announced to the membership via Regulatory Circular at least one day 
before implementation of the change.
    (c) Enhanced Specialist Participation: For options subject to the 
Enhanced Specialist Participation as set forth in Rules 1014(g)(ii)-
(iv), the specialist shall be entitled to receive a number of contracts 
(not to exceed the size of the specialist's quote) that is the greater 
of the amount he would be entitled to receive pursuant to Rules 
1014(g)(ii)-(iv), or the amount he would otherwise receive pursuant to 
the operation of the algorithm described above.
    (d) Broker-dealer Orders: If any contracts remain to be allocated 
after the [specialist, SQTs and non-SQT ROTs with limit orders on the 
limit order book] Phlx XL Participants have received their respective 
allocations, off-floor broker-dealers (as defined in Rule 
1080(b)(i)(C)) that have placed limit orders on the limit order book 
which represent the Exchange's disseminated price shall be entitled to 
receive a number of contracts that is the proportion of the aggregate 
size associated with off-floor broker-dealer limit orders on the limit 
order book at the disseminated price represented by the size of the 
limit order they have placed on the limit order book. Such off-floor 
broker-dealers shall not be entitled to receive a number of contracts 
that is greater than the size that is associated with each such limit 
order.
    (e) No Phlx XL Participant shall be entitled to receive a number of 
contracts that is greater than the size that is associated with their 
quotation or limit order.
    (2) [If the specialist is not quoting at the Exchange's 
disseminated price, SQTs quoting at the disseminated price and non-SQT 
ROTs that have placed limit orders on the limit order book via 
electronic interface which represent the Exchange's disseminated price 
shall be entitled to receive a number of contracts equal to the 
proportion of the aggregate size associated with SQT quotes and non-SQT 
ROT limit orders on the book entered via electronic interface at the 
disseminated price represented by the size of the SQT's quote or, in 
the case of a non-SQT ROT, by the size of the limit order they have 
placed on the limit order book via electronic interface. Thereafter, 
off-floor broker-dealers that have placed limit orders on the limit 
order book which represent the Exchange's disseminated price shall be 
entitled to receive a number of contracts as specified in paragraph 
(1)(d) above.
    (3)] No Split-Price Executions in Streaming Quote Options. If the 
size associated with a market order or an electronic quotation to be 
executed in a Streaming Quote Option is received for a greater number 
of contracts than the Exchange's disseminated size, the portion of such 
an order or quotation executed automatically at the

[[Page 71862]]

Exchange's disseminated size shall be allocated automatically in 
accordance with Rule 1014(g)(vii). Contracts remaining in such an order 
shall be represented by the specialist and handled in accordance with 
Exchange rules.
    ([4]3) Notwithstanding the first sentence of Rule 1014(g)(i), 
neither Rule 119(a)-(d) and (f), nor Rule 120 (insofar as it 
incorporates those provisions by reference) shall apply to the 
allocation of automatically executed trades in Streaming Quote Options.
    (h) No change.
    Commentary: No change.
* * * * *

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

    In its filing with the Commission, Phlx 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. Phlx 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 purpose of the proposed rule change is to adopt a new trade 
allocation algorithm for trades executed electronically on Phlx XL,\7\ 
to establish a weighted formula that would provide an equal allocation 
of a certain percentage of executed contracts among Phlx XL 
Participants on parity,\8\ and an allocation of contracts based on a 
size pro rata formula for the remaining contracts. The proposed 
allocation algorithm would allocate orders based on two separate 
components: parity (i.e., multiple participants quoting at the best 
price) and depth of liquidity (i.e., size pro rata). The two components 
would be weighted on a percentage basis as described below. Under the 
proposal, all equity options traded on Phlx XL would be subject to the 
same weighted percentage, while each index option traded on Phlx XL 
could be weighted differently, on a product-by-product basis.
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    \7\ See Securities Exchange Act Release No. 50100 (July 27, 
2004), 69 FR 46612 (August 3, 2004) (SR-Phlx-2003-59).
    \8\ Pursuant to Phlx Floor Procedure Advice F-11, ROTs of the 
same Firm, dually affiliated or financially affiliated ROTs, when 
bidding or offering at the same price for the same option, are to be 
treated as one interest for purpose of splitting an order in the 
trading crowd.
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Component A

    Component A of the allocation algorithm is the parity component, 
which would treat all Phlx XL Participants quoting at the relevant best 
bid or best offer as equal. Accordingly, the percentage used for 
Component A is an equal percentage, derived by dividing 100 by the 
number of market participants quoting at the best price, except as 
provided in Phlx Floor Procedure Advice F-11.\9\
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    \9\ Id.
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Component B

    Component B of the allocation algorithm is the size pro-rata 
component designed to reward market participants who quote with size. 
The percentage used for Component B is the percentage that the size of 
each market participant's quote at the best price represents relative 
to the total number of contracts in the disseminated quote (i.e., size 
pro rata).

Weighting of Each Component

    The final weighting formula for equity options would be determined 
by a three-member special committee of the Phlx Board of Governors and 
would apply uniformly across all equity options. The committee will be 
chaired by the Chairman of the Phlx Board and will include the Chairman 
of the Phlx Options Committee and one on-floor Phlx Governor (``Special 
Committee'').\10\ Each index traded on the Exchange could be weighted 
differently by the Special Committee, on a product-by-product basis. 
Initially, the Exchange proposes to assign equal weighting to 
Components A and B for all Exchange-traded products. The assigned 
weightings of Components A and B would be multiplied by the percentages 
derived for Components A and B, respectively, and then would be 
multiplied by the size of the incoming order.
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    \10\ Phlx By-Law Article IV, Section 4-4(b)(xviii) authorizes a 
majority of the Phlx Board of Governors to designate one or more ad 
hoc or special committees, each to consist of two (2) or more 
Governors, to have such duties, powers and authority as the Board of 
Governors determines.
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Additional Features

    Public customer priority. Public customer orders on the limit order 
book and at the Exchange's Best Bid or Offer (``BBO'') would continue 
to have priority.\11\ Multiple public customer orders on the limit 
order book at the same price would be ranked based on time priority. If 
a public customer order on the limit order book matches, or is matched 
by, a Phlx XL Participant's quote, the public customer order would have 
priority, and the balance of the electronic order, if any, would be 
allocated based on the new allocation algorithm.
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    \11\ Phlx rules currently provide that equity option and index 
option orders of ``controlled accounts'' are required to yield 
priority to customer orders when competing at the same price. A 
``controlled account'' includes any account controlled by or under 
common control with a broker-dealer. Customer accounts are all other 
accounts. See Phlx Rule 1014(g)(i)(A).
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    Quoting alone. A Phlx XL Participant quoting alone at the BBO would 
continue to have priority and would be entitled to receive a number of 
contracts executed against inbound quotes or orders up to the size of 
its quote.\12\
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    \12\ See Phlx Rule 1014(g)(vii)(A).
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    Enhanced Specialist Participation. For options subject to the 
Enhanced Specialist Participation,\13\ the specialist would be entitled 
to receive a number of contracts (not to exceed the size of the 
specialist's quote) that is the greater of the amount he would be 
entitled to receive pursuant to the Enhanced Specialist Participation 
described in Phlx Rules 1014(g)(ii)-(iv), or the amount he would 
otherwise receive pursuant to the operation of the new algorithm.
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    \13\ The Enhanced Specialist Participation is a percentage of an 
order to which the specialist is entitled after limit orders with 
priority over the specialist have been executed. See Phlx Rules 
1014(g)(ii)--(iv).
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    Off-floor broker-dealer orders and orders that are handled manually 
by the specialist will continue to be handled in accordance with Phlx 
Rules 1014(g)(i)(A) and 1080(b)(i)(C) and Commentary .05 thereto.
2. Statutory Basis
    The Exchange believes that its proposal, as amended, is consistent 
with Section 6(b) of the Act,\14\ in general, and furthers the 
objectives of Section 6(b)(5) of the Act,\15\ in particular, in that it 
is designed to perfect the mechanisms of a free and open market and the 
national market system, protect investors and the public interest and 
promote just and equitable principles of trade by expressly providing a 
mechanism to allocate trades among Phlx XL Participants on parity.
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    \14\ 15 U.S.C. 78f(b).
    \15\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

[[Page 71863]]

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

    No written comments were either 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. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-Phlx-2004-57 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-Phlx-2004-57. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal offices of the 
Exchange. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
Phlx-2004-57 and should be submitted on or before January 3, 2005.

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

    After careful consideration, 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,\16\ and, in particular, with the requirements of section 6(b) 
of the Act \17\ and the rules and regulations thereunder. The 
Commission finds that the proposed rule change, which establishes a new 
allocation algorithm, is consistent with section 6(b)(5) of the 
Act,\18\ which requires that the rules of an exchange be designed to 
promote just and equitable principles of trade, remove impediments to 
and perfect the mechanism of a free and open market and a national 
securities system, and, in general, protect investors and the public 
interest.
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    \16\ In approving this rule, the Commission notes that it has 
considered its impact on efficiency, competition and capital 
formation. 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78f(b).
    \18\ 15 U.S.C. 78f(b)(5).
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    Specifically, the Commission believes that the proposed allocation 
algorithm may enhance incentives to quote competitively by providing 
all market participants with the opportunity to participate in the 
allocation of trade, regardless of their disseminated size, if they are 
quoting at the disseminated price. The proposal also should provide 
incentives for Phlx XL participants to quote in greater size to obtain 
a larger allocation under Component B of the proposed allocation 
algorithm.
    The Commission finds good cause, pursuant to section 19(b)(2) of 
the Act,\19\ for approving the proposed rule change prior to the 30th 
day after the date of publication of the notice of the filing thereof 
in the Federal Register. The Commission notes that the proposal is 
substantially similar to the Chicago Board Options Exchange, Inc. Rule 
6.45A,\20\ which was previously approved by the Commission after notice 
and comment, and, therefore, does not raise any new regulatory issues.
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    \19\ 15 U.S.C. 78s(b)(2).
    \20\ See Securities Exchange Act Release No. 47959 (May 30, 
2003), 68 FR 34441 (June 9, 2003) (SR-CBOE-2002-05).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\21\ that the proposed rule change and Amendments Nos. 1, 2, 3, and 
4 thereto (SR-Phlx-2004-57) are hereby approved on an accelerated 
basis.
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    \21\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E4-3594 Filed 12-9-04; 8:45 am]
BILLING CODE 8010-01-P