[Federal Register Volume 70, Number 124 (Wednesday, June 29, 2005)]
[Notices]
[Pages 37458-37461]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-3379]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51907; File No. SR-NYSE-2004-13]


Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Approving Proposed Rule Change and Notice of Filing and Order 
Granting Accelerated Approval to Amendments No. 2 and No. 3 Thereto To 
Adopt Rule 405A (``Non-Managed Fee-Based Account Programs--Disclosure 
and Monitoring'')

June 22, 2005.

I. Introduction

    On February 25, 2004, the New York Stock Exchange, Inc. (``NYSE'' 
or the ``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or the ``Commission''), pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to prescribe certain requirements 
for members and member organizations that offer programs that charge 
customers a fixed-fee or percentage of account value in lieu of 
commissions. On October 22, 2004, the NYSE filed Amendment No. 1 to the 
proposed rule change.\3\ Notice of the proposed rule change, as amended 
by Amendment No. 1, was published for comment in the Federal Register 
on November 1, 2004.\4\ The Commission received four comment letters in 
response to the proposed rule change.\5\ On June 21, 2005, the NYSE 
filed Amendment No. 2 and Amendment No. 3 to the proposed rule.\6\ This 
order approves the proposed rule change, as amended. The Commission is 
granting accelerated approval of Amendment No. 2 and Amendment No. 3, 
and is soliciting comments from interested persons on those amendments.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Mary Yeager, Assistant Corporate Secretary, 
NYSE, to Katherine A. England, Assistant Director, Division of 
Market Regulation, Commission, dated October 22, 2004.
    \4\ See Securities Exchange Act Release No. 50586 (Oct. 25, 
2004), 69 FR 63424 (``Notice'').
    \5\ See letters to Jonathan G. Katz, Secretary, Commission, 
from: Ira D. Hammerman, General Counsel, Securities Industry 
Association, dated November 22, 2004 (``SIA Letter''); Rosemary J. 
Shockman, President, Public Investors Arbitration Bar Association, 
dated November 19, 2004 (``PIABA Letter''); Barbara Black, Co-
Director, Jill I. Gross, Co-Director, and Bob Kim, Student Intern, 
Pace Investor Rights Project, dated November 22, 2004 (``PIRP 
Letter''); and Curt Bradbury, Chief Operating Officer, Stephens 
Inc., dated November 22, 2004 (``Stevens Letter'').
    \6\ See Form 19b-4 dated June 21, 2005 (``Amendment No. 2'') and 
Form 19b-4 dated June 21, 2005 (``Amendment No. 3''). As discussed 
below, in response to commenters, in Amendment No. 2, the NYSE 
proposed to eliminate a requirement that its members provide 
customers with an annual disclosure document and that its members 
attempt to determine ``projected customer costs.'' Amendment No. 2 
also proposed to make several minor changes to clarify the rule as 
originally proposed. Amendment No. 3 corrected a non-substantive 
typographical rule text error included in Exhibit 5 of the Amendment 
No. 2 filing.
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II. Background and Description of Proposed Rule Change

    According to the NYSE, members and member organizations of the NYSE 
are increasingly offering Non-Managed Fee Based Account Programs 
(``NFBA Programs'') to their customers. NFBA Programs are agreements 
between a broker-dealer and a customer in which the customer is charged 
a fixed fee and/or a percentage of account value rather than 
transaction-based commissions.\7\ Because of their fee structure, such 
arrangements may not be appropriate for customers who trade 
infrequently. To address the particular regulatory challenges presented 
by NFBA Programs, the NYSE proposed new Rule 405A.
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    \7\ See proposed NYSE Rule 405A(6).
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A. General Disclosure Required

    Proposed Rule 405A would require NYSE members to provide to each 
customer, prior to the opening of an NFBA Program account, a disclosure 
document describing the types of NFBA Programs available to the 
customer.\8\ For each type of Program, the document must include 
sufficient information to enable a customer to make a reasonably 
informed determination as to whether the Program is appropriate for him 
or her. This information should include, at minimum, a description of 
the services provided, eligible assets, fees charged, an explanation of 
how costs will be computed and/or the provision of cost estimates based 
on hypothetical portfolios, any conditions or restrictions imposed, and 
a summary of the Program's advantages and disadvantages.
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    \8\ See proposed NYSE Rule 405A(1).
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B. Opening of Accounts

    Proposed Rule 405A would require NYSE members to make a 
determination, prior to opening an account in an NFBA Program, that 
such Program is appropriate for each customer taking into account the 
services provided, anticipated costs, and customer objectives.\9\ In 
making such determination, cost would be an important factor, but not 
the only one, that a member should consider. NYSE members would be 
required to consider the overall needs and objectives of the customer 
when determining the appropriateness of an NFBA Program for that 
customer, including the anticipated level of trading activity in the 
account and non-price factors, such as the importance that a customer 
places on aligning his or her interests with those of the broker.
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    \9\ See proposed NYSE Rule 405A(2).
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C. Monitoring of Accounts

    Proposed Rule 405A would require NYSE members to establish and 
maintain systems and procedures to enable them to monitor, on an 
ongoing basis, transactional activity by customers in NFBA 
Programs.\10\ These systems and procedures would need to include 
specific written criteria for identifying customers whose level of 
account activity may be inappropriate in the context of the customer's 
Program. The determination of appropriateness would take into 
consideration not only costs incurred, but also Program services, 
customer investment objectives, and customer preferences.
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    \10\ See proposed NYSE Rule 405A(3).

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[[Page 37459]]

D. Review and Follow-Up

    The proposed rule would require each NYSE member to maintain 
written procedures for contacting and following up with customers whose 
accounts are identified in the monitoring stage.\11\ The timeframe for 
identifying such customers should be, at minimum, a rolling 12 month 
period, though more frequent contact would be required should 
circumstances warrant. While the proposed rule does not prescribe 
specific procedures for identifying, contacting, and following up with 
customers, the means (e.g., letter, phone call, or e-mail) and general 
content of any unwritten follow-up customer contact would have to be 
documented and retained in an easily accessible place.\12\
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    \11\ See proposed NYSE Rule 405A(4).
    \12\ The proposed rule would not alter any recordkeeping 
requirements imposed on broker-dealers by Rules 17a-3 and 17a-4 
under the Act. 17 CFR 200.17a-3 and 17-4.
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E. Applicability of Rule

    Because proposed Rule 405A is intended to protect the interests of 
retail customers, it contains an exception for accounts opened on 
behalf of ``Qualified Investors'' as that term is defined in section 
3(a)(54) of the Act.\13\ This exception is based on the assumption that 
such accounts are generally directed by persons that are financially 
sophisticated and thus better able to make informed decisions regarding 
the appropriateness of available NFBA Programs. The proposed rule also 
does not apply to any NYSE member that does not offer NFBA Programs to 
its customers.
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    \13\ See proposed NYSE Rule 405A(5).
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F. Supplementary Material

    Proposed Rule 405A contains supplementary material reminding NYSE 
members that they have an obligation, under NYSE Rule 405(1), to ``use 
due diligence to learn the essential facts relative to every customer 
and every cash or margin account, including accounts in Non-Managed 
Fee-Based Account Programs, accepted or carried by such member 
organization.'' \14\
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    \14\ See proposed Rule 405A (Supplementary Material).
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III. Summary of Comments on the Proposed Rule Change

    The Commission received four comment letters on the proposed rule 
change.\15\ Two comment letters generally supported the proposal,\16\ 
although one of them thought that the proposed rule failed to address 
what this commenter viewed as the larger problems customers face with 
fee-based accounts.\17\ Two comment letters opposed it.\18\
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    \15\ See supra note 5.
    \16\ See PIRP Letter and PIABA Letter.
    \17\ See PIABA Letter (expressing concern regarding the proposed 
rule's silence regarding the suitability obligations of members when 
recommending outside investment advisers and the rule's failure to 
address the obligations of members to monitor the suitability of the 
activity within an NFBA Program).
    \18\ See SIA Letter and Stevens Letter.
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    Two commenters objected to the requirement in the proposed rule 
that members determine ``projected customer costs.'' \19\ For example, 
one commenter argued that it would be ``difficult and potentially 
misleading to project customer costs with any degree of accuracy.'' 
\20\ The same commenter also contended that the disclosure document 
does not need to be delivered annually, and that it could be 
incorporated into existing account opening documentation.
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    \19\ Id.
    \20\ See SIA Letter (suggesting instead that members ``explain 
how costs will be computed and/or provide cost estimates based on 
hypothetical portfolios''), and see also Stevens Letter (arguing 
that determining ``projected customer costs'' is ``unduly 
burdensome'' and a matter of ``pure guesswork''). Another commenter 
recommended that a disclosure document be provided that would allow 
a customer ``to compare the cost of a fee-based program with a 
commission-based program for a given level of transaction volume and 
asset mix.'' See PIRP Letter.
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    One commenter suggested that the proposal should clearly state that 
members may consider representations by the customer regarding 
anticipated levels of trading activity when determining whether it is 
appropriate to open an account in an NFBA Program, even though that 
representation alone may not be determinative in cases where the NFBA 
Program offers a preferred level of services.\21\ Another commenter 
criticized the proposed rule because, ``by solely focusing on cost,'' 
the proposed rule ``undervalues the attention given by a broker to his 
customer and the advice of the broker,'' including advice not to trade, 
when appropriate.\22\
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    \21\ See SIA Letter.
    \22\ See Stephens Letter. See also SIA Letter and PIRP Letter 
(arguing that, while non-cost factors should play a role in 
determining whether a NFBA Program is appropriate for a customer, 
they should not be used to justify extreme payment differentials 
over pay-per-trade arrangements).
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    Two commenters objected to the requirement that members establish 
and maintain systems and procedures adequate to monitor, on an ongoing 
basis, transactional activity by customers in NFBA Programs.\23\ One of 
these argued that, given that activity levels may not be the only 
factor in determining whether an NFBA Program is appropriate for 
customers, the development of transactional monitoring systems would be 
of limited use.\24\ Another commenter argued that the proposal's focus 
on the cost of transactional activity alone to identify customers for 
follow-up may create the presumption that certain customers should have 
been in different kinds of accounts.\25\
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    \23\ See SIA Letter and Stevens Letter.
    \24\ See SIA Letter (arguing also that requiring each member to 
develop an ``automated surveillance system'' would be onerous and 
costly).
    \25\ See Stevens Letter.
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    Two commenters objected to the annual review period for determining 
which customer accounts must be followed up with.\26\ One of these 
commenters thought that the review period should be 24 months.\27\ The 
other commenter argued that it should be 36 months.\28\ One commenter 
opined that once a customer account is identified in the monitoring 
stage as requiring follow-up, the proposed rule could imply that 
members would be required to follow up with the customer indefinitely 
regardless of whether the customer's account continues to be 
identified.\29\
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    \26\ See SIA Letter and Stevens Letter.
    \27\ See SIA Letter.
    \28\ See Stevens Letter.
    \29\ See SIA Letter.
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    Two commenters objected to the exception in the proposed rule for 
``Qualified Investors.'' \30\ One argued that the exception should be 
expanded to include ``accredited investors'' or any institutional 
customer with at least $10 million invested in securities in the 
aggregate.\31\ It also argued that the proposed rule should not include 
accounts managed by independent investment advisory firms because these 
accounts are ``managed.'' The other commenter did not think pension 
plans with investment advisers should be excepted from the rule.\32\
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    \30\ See SIA Letter and PIABA Letter.
    \31\ See SIA Letter.
    \32\ See PIABA Letter (arguing that many pension plans of 
medical clinics and professional practices have trustees that are 
not sophisticated enough to select an appropriate investment 
adviser).
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IV. Amendment No. 2 to the Proposed Rule Change

    In Amendment No. 2, the NYSE modified the proposal to address 
certain comments received concerning the proposed rule change.

A. General Disclosure Requirements

    As originally proposed, NYSE Rule 405A would have required NYSE 
members to provide an annual disclosure document to customers with

[[Page 37460]]

an NFBA Program account.\33\ Concluding that such disclosure would, in 
many instances, be redundant, the NYSE omitted this requirement.\34\ As 
originally proposed, the NYSE rule would also have required NYSE 
members to disclose ``projected customer costs.'' \35\ Responding to 
the concerns of two commenters,\36\ the NYSE determined that ``due to 
the varying nature of Program features as well as the uncertainty of 
prospective trading volumes, `projected customer costs' may be a 
somewhat speculative standard.'' Amendment No. 2, therefore, eliminates 
this requirement and replaces it with the requirement that NYSE members 
provide ``an explanation of how costs will be computed and/or the 
provision of cost estimates based on hypothetical portfolios.''
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    \33\ See Notice, 69 FR at 63424.
    \34\ Amendment No. 2. However, as a matter of good business 
practice, the NYSE strongly advises that any significant changes or 
updates in a member organization's menu of NFBA Programs be brought 
to the attention of existing customers to assist them in making a 
determination as to whether they are in a Program that best suits 
their current investment objectives.
    \35\ See Notice, 69 FR at 63424-25.
    \36\ See SIA Letter and Stevens Letter.
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B. Monitoring of Accounts

    As originally proposed, the NYSE rule would have required NYSE 
members to develop systems and procedures that include ``transaction 
parameters for identifying customer account activity that may be 
inconsistent with the Program costs incurred by the customers.'' \37\ 
Amendment No. 2 eliminates the ``transaction parameters'' requirement 
and replaces it with a requirement that NYSE members develop systems 
and procedures that include ``written criteria for identifying 
customers whose level of account activity may be inappropriate in the 
context of the customer's Program.'' \38\ In making this change, 
Amendment No. 2 clarifies that it was not the NYSE's intention to 
require its members to develop or acquire an automated system to 
monitor their NFBA Program accounts.
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    \37\ See Notice, 69 FR at 63424.
    \38\ Amendment No. 2 notes that: ``The determination of 
appropriateness should take into consideration costs incurred, 
Program services, customer investment objectives, and customer 
preferences.''
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C. Review and Follow-Up

    As originally proposed, the NYSE rule would have required that NYSE 
members maintain written procedures for contacting and following up 
with customers for whom NFBA accounts might be inappropriate, at 
minimum, every 12 months.\39\ Amendment No. 2 modifies the follow-up 
requirement period to a rolling 12 months. This change responds to the 
concern of one commenter that the original proposal could imply that 
members were required to follow up with flagged customers in 
perpetuity.\40\ Amendment No. 2 now clarifies that subsequent contacts 
are to be based upon subsequent activity reviews (i.e., ``as 
appropriate'').\41\
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    \39\ See Notice, 69 FR at 63425.
    \40\ See SIA Letter.
    \41\ Amendment No. 2 also gives ``e-mail'' as an example of a 
permissible means of customer contact.
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V. Discussion

    After careful consideration of the proposal and the comments 
received, the Commission finds that the proposed rule change, as 
amended, is consistent with the requirements of the Act and the rules 
and regulations thereunder applicable to a national securities 
exchange,\42\ and, in particular, the requirements of section 6 of the 
Act \43\ and the rules and regulations thereunder. The Commission finds 
specifically that the proposed rule change is consistent with section 
6(b)(5) of the Act,\44\ 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 a national market system, and, 
in general, to protect investors and the public interest.
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    \42\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \43\ 15 U.S.C. 78f.
    \44\ 15 U.S.C. 78f(b)(5).
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    Fee-based accounts have become more popular over the last several 
years as commission revenue has declined with the decrease in trading 
volumes. Such accounts can benefit broker-dealers by providing them 
with a steady stream of revenue that is less dependent on short-term 
fluctuations in trading activity. Such accounts can also benefit 
customers by removing an incentive for broker-dealers to encourage 
trading in an account to increase commission revenue. At the same time, 
however, such accounts are not appropriate for every investor. One 
concern raised by fee-based accounts is that customers are being 
inappropriately moved into these accounts when commission-based 
accounts would cost them less due to their low volume of trading. 
Another concern is that there is currently little or no monitoring and 
follow-up required with customers whose trading activity has changed 
over time and for whom a fee-based account is no longer 
appropriate.\45\ The NYSE proposal should help to ensure that customers 
are placed in the account that is the most appropriate for them.\46\
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    \45\ See, e.g., Aaron Pressman and Amy Borrus, ``A Poor Fit for 
Investors?,'' Business Week, May 9, 2005, pp. 78-79; Kaja 
Whitehouse, ``Some Investors Can Be Left Flat by Annual Fees,'' The 
Wall Street Journal, April 14, 2004, at D7; and Ruth Simon, ``Fee 
Accounts Face Scrutiny by Regulators--SEC, Others Probe Programs 
that Charge Investors Fees Instead of Commissions for Trades,'' The 
Wall Street Journal, October 5, 2004, at D1.
    \46\ For dual NYSE and NASD members the new NYSE Rule 405A will 
augment guidance that NASD provided in NASD NTM 03-68 (Nov. 2003) 
regarding fee-based compensation programs.
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    The Commission believes the proposed rule change strengthens the 
NYSE's ability to address the particular regulatory concerns raised by 
NFBA Programs.\47\ The Commission further believes that the proposed 
rule change should help to ensure that customers receive sufficient 
information to make a reasonably informed determination as to whether 
an NFBA Program is appropriate for them.\48\ Although the Commission 
believes that cost is likely to be the key factor in determining 
whether a customer should be in an NFBA Program, it also believes that 
it is appropriate to consider other factors as well, such as the 
services provided and customer objectives and preferences. This 
appropriateness determination is strengthened by the requirement in the 
proposed rule that NYSE members establish and maintain systems and 
procedures adequate to monitor, on an ongoing basis, transactional 
activity by customers in NFBA Programs.\49\ In Amendment No. 2, the 
NYSE amended the proposed rule to provide that the systems and 
procedures must include only ``written criteria'' (rather than 
``specific transactional parameters or criteria''). The Commission 
believes that

[[Page 37461]]

this amendment is appropriate because it clarifies that the proposed 
rule does not require that NYSE members generate ``automated exception 
reports.'' \50\
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    \47\ The Commission agrees with the NYSE that, given the growth 
of these programs, ``specific, enforceable standards of compliance 
are warranted.'' See Amendment No. 2. Because the proposed rule, as 
amended, provides firms flexibility in implementing compliance 
procedures, the Commission does not believe that it will discourage 
firms from offering these programs.
    \48\ While the Commission believes that an annual disclosure 
requirement and a requirement that members determine ``projected 
customer costs,'' both of which were originally proposed, could have 
strengthened the rule, we do believe that the amended proposal will 
provide investors with a degree of protection from being in placed 
in inappropriate accounts that is not currently available. Moreover, 
the Commission notes that the disclosure requirement is complemented 
by the additional requirement in the proposed rule that NYSE members 
make an appropriateness determination prior to opening an account in 
an NFBA Program. See proposed Rule 405A(2).
    \49\ See proposed Rule 405A(3).
    \50\ Two commenters raised this concern. See SIA Letter and 
Stevens Letter. The Commission notes that identifying customers 
whose level of account activity may be inappropriate in the context 
of the customer's Program does not create ``a presumption that 
certain customers should have been in different types of accounts,'' 
as one commenter was concerned. See Stevens Letter. Rather, the 
Commission believes it provides, as the NYSE states, ``an 
opportunity to determine appropriateness.'' See Amendment No. 2. 
Nevertheless, the Commission expects that the NYSE will conduct 
regular examinations to determine the frequency with which firms are 
placing customers in NFBA Programs that are inappropriate for those 
customers. A high percentage of initial placements in inappropriate 
accounts by a particular member or registered representative may 
suggest a need for more vigorous procedures for determining the 
appropriateness of account placement.
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    The Commission believes that the follow-up requirement in the 
proposed rule will ensure that members take active steps to contact 
customers who may be in inappropriate accounts.\51\ Amendment No. 2 
clarifies that NYSE members are only required to follow up with 
customers so long as they continue to be identified in the monitoring 
stage by adding the words ``as appropriate'' to the end of the first 
sentence of paragraph (4). The Commission agrees with the NYSE that a 
12-month review cycle is a reasonable review period to flag customers 
who may be in inappropriate accounts. Because the proposed rule does 
not prescribe the means to follow up with customers, it should not be 
difficult to integrate the proposed requirements into member 
organizations' existing systems and procedures for follow-up customer 
contact.\52\
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    \51\ See proposed Rule 405A(4).
    \52\ The Commission does not agree with one commenter that it 
will be difficult to make effective contact with customers on an 
annual basis or necessitate a ``tremendous use of personnel 
resource, unavailable to most firms.'' See Stevens Letter.
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    The Commission believes that the exception in the proposed rule for 
``Qualified Investors,'' as that term is defined in section 3(a)(54) of 
the Exchange Act, is appropriate.\53\ As the NYSE correctly notes, 
underlying the Qualified Investor standard is the presumption that such 
persons are sophisticated investors who are capable of ensuring 
responsible handling of funds under management.\54\ Accordingly, the 
level of disclosure required for retail customers may not be warranted 
for such investors.
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    \53\ See proposed Rule 405A(5).
    \54\ See Amendment No. 2.
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    The Commission finds good cause for approving Amendment No. 2 and 
Amendment No. 3 before the thirtieth day after the date of publication 
of notice of filing thereof in the Federal Register. Amendment No. 2 
clarifies certain aspects of the proposed rule that commenters found 
confusing, as well as makes minor changes to give members greater 
flexibility in the administration of the proposed rule. Amendment No. 3 
corrects a non-substantive typographical rule text error included in 
Exhibit 5 of the Amendment No. 2 filing.

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment No. 2 
and Amendment No. 3 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-NYSE-2004-13 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-NYSE-2004-13. 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, 100 F Street, 
NE., Washington, DC 20549-9303. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
NYSE. 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-
NYSE-2004-13 and should be submitted on or before July 20, 2005.

VII. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\55\ that the proposed rule change (File No. SR-NYSE-2004-13) be, 
and it hereby is, approved.
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    \55\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\56\
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    \56\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-3379 Filed 6-28-05; 8:45 am]
BILLING CODE 8010-01-P