[Federal Register Volume 69, Number 250 (Thursday, December 30, 2004)]
[Notices]
[Pages 78508-78511]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-28582]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50916; File No. SR-NASD-2004-188]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by National 
Association of Securities Dealers, Inc. Relating to the Listing and 
Trading of Performance Leveraged Upside Securities Based on the Value 
of the Index

December 22, 2004.
    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 December 21, 2004, 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'' or ``SEC'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by Nasdaq. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons and is approving the 
proposal on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    The Nasdaq proposed to list notes, know as Performance Leveraged 
Upside Securities\SM\ (``Notes'') issued by Morgan Stanley (``Morgan 
Stanley''), the performance of which is linked to the Nasdaq-100 
(``Nasdaq-100'' or ``Index'').

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 Nasdaq 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 Nasdaq 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
    Nasdaq proposes to list and trade Performance Leveraged Upside 
Securities (``PLUS''), the return on which is based upon the Nasdaq-100 
Index (the ``Index'').\3\
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    \3\ The Index is a modified capitalization-weighted index of 100 
of the largest non-financial companies listed on The Nasdaq National 
Market tier of The Nasdaq Stock Market. The Index constitutes a 
broadly diversified segment of the largest securities listed on The 
Nasdaq Stock Market and includes companies across a variety of major 
industry groups. The securities in the Index must, among other 
things, have an average daily trading volume on Nasdaq of at least 
200,000 shares.
    In order to ensure that there is no domination of the Index by a 
few large stocks, the Index is calculated under a ``modified 
capitalization-weighted'' methodology, which is a hybrid between 
equal weighting and conventional capitalization weighting. Under the 
methodology employed, on a quarterly basis coinciding with Nasdaq's 
quarterly scheduled weight adjustment procedures, the Index 
Securities are categorized as either ``Large Stocks'' or ``Small 
Stocks'' depending on whether their current percentage weights 
(after taking into account such scheduled weight adjustments due to 
stock repurchases, secondary offerings, or other corporate actions) 
are greater than, or less than or equal to, the average percentage 
weight in the Index (i.e., as a 100-stock index, the average 
percentage weight in the Index is 1.0%). Such quarterly examination 
will result in an Index rebalancing if either one or both of the 
following two weight distribution requirements are not met: (1) The 
current weight of the single largest market capitalization Index 
component security must be less than or equal to 24.0%, and (2) the 
``collective weight'' of those Index component securities whose 
individual current weights are in excess of 4.5%, when added 
together, must be less than or equal to 48.0%.
    Index securities are ranked by market value and are evaluated 
annually to determine which securities will be included in the 
Index. Moreover, if at any time during the year an Index security is 
no longer trading on the Nasdaq Stock Market, or is otherwise 
determined by Nasdaq to become ineligible for continued inclusion in 
the Index, the security will be replaced with the largest market 
capitalization security not currently in the Index that meets the 
Index eligibility criteria.
    For a detailed description of the Index, see the prospectus 
supplement that will be filed by Morgan Stanley with the Commission 
prior to the issuance of the Notes. The Index is widely disseminated 
at Bloomberg, Reuters and Thomson Financial, where its value is 
updated every 15 seconds during normal trading hours. In the event 
that the calculation and this type of dissemination of the Index is 
discontinued, Nasdaq will delist the notes.
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    Under NASD Rule 4420(f), Nasdaq may approve for listing and trading 
innovative securities which cannot be readily categorized under 
traditional listing guidelines.\4\ Nasdaq proposes to

[[Page 78509]]

list for trading notes based on the Index under NASD Rule 4420(f).
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    \4\ See Securities Exchange Act Release No. 32988 (September 29, 
1993), 58 FR 52124 (October 6, 1993).
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    The Notes, which will be registered under Section 12 of the Act, 
will initially be subject to Nasdaq's listing criteria for other 
securities under NASD Rule 4420(f). Specifically, under NASD Rule 
4420(f)(1):
    (A) The issuer shall have assets in excess of $100 million and 
stockholders' equity of at least $10 million.\5\ In the case of an 
issuer which is unable to satisfy the income criteria set forth in 
paragraph (a)(1), Nasdaq generally will require the issuer to have the 
following: (i) Assets in excess of $200 million and stockholders' 
equity of at least $10 million; or (ii) assets in excess of $100 
million and stockholders' equity of at least $20 million;
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    \5\ Morgan Stanley satisfies this listing criterion.
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    (B) There must be a minimum of 400 holders of the security, 
provided, however, that if the instrument is traded in $1,000 
denominations, there must be a minimum of 100 holders;
    (C) For equity securities designated pursuant to this paragraph, 
there must be a minimum public distribution of 1,000,000 trading units;
    (D) The aggregate market value/principal amount of the security 
will be at least $4 million.
    In addition, Morgan Stanley satisfies the listed marketplace 
requirement set forth in NASD Rule 4420(f)(2).\6\ Lastly, pursuant to 
NASD Rule 4420(f)(3), prior to the commencement of trading of the 
Notes, Nasdaq will distribute a circular to members providing guidance 
regarding compliance responsibilities and requirements, including 
suitability recommendations, and highlighting the special risks and 
characteristics of the Notes. In particular, Nasdaq will advise members 
recommending a transaction in the Notes to: (1) determine that such 
transaction is suitable for the customer; and (2) have a reasonable 
basis for believing that the customer can evaluate the special 
characteristics of, and is able to bear the financial risks of, such 
transaction.
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    \6\ NASD Rule 4420(f)(2) requires issuers of securities 
designated pursuant to this paragraph to be listed on The Nasdaq 
National Market or the New York Stock Exchange (``NYSE'') or be an 
affiliate of a company listed on The Nasdaq National Market or the 
NYSE; provided, however, that the provisions of NASD Rule 4450 will 
be applied to sovereign issuers of ``other'' securities on a case-
by-case basis.
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    The Notes will be subject to Nasdaq's continued listing criterion 
for other securities pursuant to NASD Rule 4450(c). Under this 
criterion, the aggregate market value or principal amount of publicly-
held units must be at least $1 million. The Notes also must have at 
least two registered and active market makers as required by NASD Rule 
4310(c)(1). The Notes will be subject to the NASD's existing trading 
halt rules. Nasdaq will also consider prohibiting the continued listing 
of the Notes if Morgan Stanley is not able to meet its obligations on 
the Notes.
    The Notes are a series of medium-term, senior non-convertible debt 
securities that will be issued by Morgan Stanley. The original public 
offering price of the Notes will be $10 per PLUS. The Notes will not 
pay interest and are not subject to redemption by Morgan Stanley or at 
the option of any beneficial owner before maturity on March 30, 2006.
    At maturity, if the value of the Index has increased, a beneficial 
owner will be entitled to receive a payment on the Notes based on 200% 
the amount of that percentage increase, subject to a maximum total 
payment at maturity that is expected to be between $11.50 and $11.70 
(the ``Maximum Payment at Maturity'').\7\ Thus, the Notes provide 
investors the opportunity to obtain leveraged returns based on the 
Index subject to a cap that is expected to represent an appreciation of 
15% to 17% over the original issue price of the Notes. Unlike ordinary 
debt securities, the Notes do not guarantee any return of principal at 
maturity. Therefore, if the value of the Index has declined at 
maturity, a beneficial owner will receive less, and possibly 
significantly less, than the original issue price of $10 per PLUS.
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    \7\ The actual Maximum Payment at Maturity will be determined at 
the time of issuance of the Notes.
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    The payment that a beneficial owner will be entitled to receive at 
maturity depends entirely on the relation of the value of the Index on 
March 30, 2006 (the ``Final Index Value'') and the value of the Index 
on the day the PLUS is offered for initial sale to the public (the 
``Initial Index Value''). If the Final Index Value is greater than the 
Initial Index Value, the payment at maturity per PLUS will equal the 
lesser of (a) $10 plus the Leveraged Upside Payment \8\ and (b) the 
Maximum Payment at Maturity. If the Final Index Value is less than or 
equal to the Initial Index Value, the payment at maturity per PLUS will 
equal $10 times the Index Performance Factor.\9\
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    \8\ The Leveraged Upside Payment is the product of (i) $10 and 
(ii) 200% and (iii) the Index Percent Increase (a fraction, the 
numerator of which is the Final Index Value minus the Initial Index 
Value and the denominator of which is the Initial Index Value).
    \9\ The Index Performance Factor is a fraction, the numerator of 
which is the Final Index Value and the denominator of which is the 
Initial Index Value.
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    The Notes are cash-settled in U.S. dollars and do not give the 
holder any right to receive a portfolio security, dividend payments or 
any other ownership right or interest in the portfolio or index of 
securities comprising the Index. The Commission has previously approved 
the listing of options on, and other securities the performance of 
which have been linked to or based on, the Index.\10\
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    \10\ See Securities Exchange Act Release Nos. 48065 (June 19, 
2003), 68 FR 38414 (June 27, 2003) (approving the listing and 
trading of Performance Leveraged Upside Securities based on the 
Value of the Nasdaq-100 Index); 45429 (February 11, 2002), 67 FR 
7438 (February 19, 2002) (approving the listing and trading of 
Enhanced Return Notes Linked to the Nasdaq-100 Index); 45024 
(November 5, 2001), 66 FR 56872 (November 13, 2001) (approving the 
listing and trading of Enhanced Return Notes Linked to the Nasdaq-
100 Index); 44913 (October 9, 2001), 66 FR 52469 (October 15, 2001) 
(approving the listing and trading of Performance Leveraged Upside 
Securities based upon the performance of the Nasdaq-100 Index); 
43000 (June 30, 2000), 65 FR 42409 (July 10, 2000) (approving the 
listing and trading of options based upon one-tenth of the value of 
the Nasdaq-100 Index); 41119 (February 26, 1999), 64 FR 11510 (March 
9, 1999) (approving the listing and trading of Portfolio Depositary 
Receipts based on the Nasdaq-100 Index); and 33428 (January 5, 
1994), 59 FR 1576 (January 11, 1994) (approving the listing and 
trading of options on the Nasdaq-100 Index).
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    As of the close of business on December 17, 2004, the adjusted 
market capitalization of the securities included in the Index ranged 
from a high of $188.2 billion to a low of $3.7 billion. As of the same 
date, the average daily trading volume for these same securities since 
the beginning of 2004 ranged from a high of 67.1 million shares to a 
low of 416,600 shares.
    Since the Notes will be deemed equity securities for the purpose of 
NASD Rule 4420(f), the NASD and Nasdaq's existing equity trading rules 
will apply to the Notes. First, pursuant to NASD Rule 2310 and IM-2310-
2, members must have reasonable grounds for believing that a 
recommendation to a customer regarding the purchase, sale or exchange 
of any security is suitable for such customer upon the basis of the 
facts, if any, disclosed by such customer as to his other security 
holdings and as to his financial situation and needs.\11\ In addition, 
as previously described, Nasdaq will distribute a circular to members 
providing guidance regarding compliance responsibilities and 
requirements, including suitability recommendations, and highlighting 
the special risks and characteristics of the

[[Page 78510]]

Notes. Furthermore, the Notes will be subject to the equity margin 
rules. Lastly, the regular equity trading hours of 9:30 a.m. to 4:00 
p.m. will apply to transactions in the Notes.
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    \11\ NASD Rule 2310(b) requires members to make reasonable 
efforts to obtain information concerning a customer's financial 
status, a customer's tax status, the customer's investment 
objectives, and such other information used or considered to be 
reasonable by such member or registered representative in making 
recommendations to the customer.
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    Nasdaq represents that NASD's surveillance procedures are adequate 
to properly monitor the trading of the Notes. Specifically, NASD will 
rely on its current surveillance procedures governing equity 
securities, and will include additional monitoring on key pricing 
dates.
    Pursuant to Rule 10A-3 of the Act and Section 3 of the Sarbanes-
Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002), Nasdaq 
will prohibit the initial or continued listing of any security of an 
issuer that is not in compliance with the requirements set forth 
therein.
    Morgan Stanley will deliver a prospectus in connection with the 
initial purchase of the Notes. The procedure for the delivery of a 
prospectus will be the same as Morgan Stanley's current procedure 
involving primary offerings.
2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A of the Act,\12\ in general, and with 
Section 15A(b)(6) of the Act,\13\ in particular, in that the proposal 
is designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and, 
in general, to protect investors and the public interest.
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    \12\ 15 U.S.C. 78o-3.
    \13\ 15 U.S.C. 78o-3(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

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

    Written comments were neither solicited nor 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 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-NASD-2004-188 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-NASD-2004-188. 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 office of the 
NASD. 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-
NASD-2004-188 and should be submitted on or before January 20, 2005.

IV. Commission's Findings and Order Granting 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 
association, and, in particular, with the requirements of Section 
15A(b)(6) of the Act.\14\ The Commission has previously approved the 
listing of options on, and securities the performance of which have 
been linked to or based on the Index.\15\ Accordingly, the Commission 
finds that listing and trading of the Notes is consistent with the Act 
and will promote just and equitable principles of trade, foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, in general, to protect 
investors and the public interest.\16\ The requirements of NASD Rule 
4420(f) were designed to address the concerns attendant to the trading 
of hybrid securities like the Notes. NASD Rule 4420(f)(2) provides that 
only issuers satisfying substantial asset and equity requirements may 
issue securities such as the Notes. In addition, Nasdaq's continued 
listing criterion for other securities further require that the Notes 
have a market value of at least $4 million.\17\ The Commission also 
notes that the 100 component stocks that comprises the Index are 
reporting companies under the Act, and the Notes will be registered 
under Section 12 of the Act. Thus, by imposing the hybrid listing 
standards, suitability, disclosure, and compliance requirements noted 
above, the Commission believes the Nasdaq has addressed adequately the 
potential problems that could arise from the hybrid nature of the 
Notes.
    In approving the product, the Commission recognizes that the Index 
is a modified capitalization-weighted index \18\ of 100 of the largest 
and most active non-financial domestic and international companies 
listed on Nasdaq. Given the large trading volume and capitalization of 
the compositions of the stocks underlying the Index, the Commission 
believes that the listing and trading of the Notes that are linked to 
the Index should not unduly impact the market for the underlying 
securities compromising the Index or raise manipulative concerns.\19\ 
Moreover, the issuers of the underlying securities comprising the Index 
are subject to reporting requirements under the Act, and all of the 
component stocks are

[[Page 78511]]

either listed or traded on, or traded through the facilities of, U.S. 
securities markets.
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    \14\ 15 U.S.C. 78o-3(b)(6).
    \15\ Supra note 10.
    \16\ In approving the proposed rule, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \17\ See NASD Rule 4450(c).
    \18\ See supra Note 3.
    \19\ The issuer Morgan Stanley disclosed in the prospectus that 
the original issue price of the Notes includes commissions (and the 
secondary market prices are likely to exclude commissions) and 
Morgan Stanley's costs of hedging its obligations under the Notes. 
These costs could increase the initial value of the Notes, thus 
affecting the payment investors receive at maturity. Such hedging 
activity must, of course, be conducted in accordance with applicable 
regulatory requirements.
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    The Commission also believes that any concerns that a broker-
dealer, such as Morgan Stanley or a subsidiary providing a hedge for 
the issuer, will incur undue position exposure are minimized by the 
size of the Notes issuance in relation to the net worth of Morgan 
Stanley.\20\
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    \20\ See Securities Exchange Act Release Nos. 44913 (October 9, 
2001), 66 FR 52469 (October 15, 2001) (order approving the listing 
and trading of notes whose return is based on the performance of the 
Nasdaq-100 Index) (File No. SR-NASD-2001-73); 44483 (June 27, 2001), 
66 FR 35677 (July 6, 2001) (order approving the listing and trading 
of notes whose return is based on a portfolio of 20 securities 
selected from the Amex Institutional Index) (File No. SR-Amex-2001-
40); and 37744 (September 27, 1996), 61 FR 52480 (October 7, 1996) 
(order approving the listing and trading of notes whose return is 
based on a weighted portfolio of healthcare/biotechnology industry 
securities) (File No. SR-Amex-96-27).
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    Finally, the Commission notes that the value of the Index will be 
widely disseminated at least once fifteen seconds throughout the 
trading day. Nasdaq represents that the Nasdaq-100 will be determined, 
calculated and maintained solely by Nasdaq.
    The Commission finds good cause for approving the proposed rule 
change prior to the 30th day after the date of publication of the 
notice of filing thereof in the Federal Register. Nasdaq has requested 
accelerated approval because this product is similar to several other 
instruments currently listed and traded on the Nasdaq.\21\ The 
Commission believes that the Notes will provide investors with an 
additional investment choice and that accelerated approval of the 
proposal will allow investors to begin trading the Notes promptly. 
Additionally, the Notes will be listed pursuant to Nasdaq's existing 
hybrid security listing standards as described above. Therefore, the 
Commission finds good cause, consistent with Section 19(b)(2) of the 
Act,\22\ to approve the proposal on an accelerated basis.
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    \21\ See Securities Exchange Act Release Nos. 45966 (May 20, 
2002), 67 FR 36942 (May 28, 2002) (approval to list and trade notes 
linked to the performance of the Nasdaq-100); 47911 (May 22, 2003), 
68 FR 32558 (May 30, 2003) (approving the listing and trading of 
notes (Wachovia TEES) linked to the S&P 500); 47983 (June 4, 2003), 
68 FR 35032 (June 11, 2003) (approving the listing and trading of a 
CSFB Accelerated Return Notes linked to S&P 500); and 50019 (July 
14, 2004), 69 FR 43635 (July 21, 2004) (approving the listing and 
trading of Morgan Stanley PLUS Notes).
    \22\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).
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    Accordingly, the Commission believes there is good cause, 
consistent with Sections 15A(b)(6) and 19(b)(2) of the Act,\23\ to 
approve the proposal, on an accelerated basis.
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    \23\ 15 U.S.C. 78o3(b)(6) and 78s(b)(2).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-NASD-2004-188) is hereby 
approved on an accelerated basis.
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    \24\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-28582 Filed 12-29-04; 8:45 am]
BILLING CODE 8010-01-P