[Federal Register Volume 81, Number 121 (Thursday, June 23, 2016)]
[Notices]
[Pages 40932-40935]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-14837]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-78094; File No. SR-FINRA-2016-014]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving Proposed Rule Change Relating to 
Composition, Terms of Members and Election Procedures for the National 
Adjudicatory Council

June 17, 2016.

I. Introduction

    On April 28, 2016, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``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 amend the By-Laws of FINRA's 
regulatory subsidiary, FINRA Regulation, Inc. (``FINRA Regulation''), 
to expand the size of the National Adjudicatory Council (``NAC'') to 15 
members, with the number of non-industry members exceeding the number 
of industry members; lengthen the terms of office of future NAC members 
to four years; and update the process used for sending and counting 
ballots in the event of a contested nomination and election to fill 
certain NAC industry member seats. The proposed rule change was 
published for comment in the Federal Register on May 13, 2016.\3\ The 
Commission received four comment letters on the proposal.\4\ 
Thereafter, FINRA submitted a letter in response to the comment 
letters.\5\ This order grants approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 77786 (May 9, 2016), 
81 FR 29929 (May 13, 2016) (``Notice'').
    \4\ See Letters from Steven B. Caruso, Esq., Maddox Hargett 
Caruso, P.C., dated May 9, 2016 (``Caruso Letter''); David T. 
Bellaire, Esq., Executive Vice President & General Counsel, 
Financial Services Institute, dated May 19, 2016 (``FSI Letter''); 
Hugh Berkson, Public Investors Arbitration Bar Association, dated 
June 2, 2016 (``PIABA Letter''); and Christopher E. Berman, Barry 
University, dated June 2, 2016 (``Berman Letter'').
    \5\ See Letter from Gary Dernelle, Associate General Counsel, 
FINRA, dated June 13, 2016 (``FINRA Letter'').
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II. Description of the Proposal \6\
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    \6\ A full description of the proposal can be found in the 
Notice. See Notice, supra note 3.
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    The FINRA Regulation By-Laws establish the composition of the 
NAC,\7\ the terms of its members, and the process by which members are 
selected. The NAC is currently composed of fourteen members.\8\ The 
number of Non-Industry Members, which must include at least three 
Public Members, equals the number of Industry Members.\9\ The

[[Page 40933]]

seven Industry Members include two Small Firm NAC Members, one Mid-Size 
Firm NAC Member, two Large Firm NAC Members and two at-large Industry 
Members.\10\
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    \7\ The NAC acts on behalf of FINRA in several capacities and 
its powers are authorized by the By-Laws of FINRA Regulation and 
FINRA's Code of Procedure. The NAC presides over disciplinary 
matters appealed to or called for review by the NAC. The NAC also 
acts, when requested, in statutory disqualification and membership 
proceedings; considers the appeals of members seeking exemptive 
relief; and retains the authority to review decisions proposed in 
other proceedings as set forth in the Code of Procedure. For most 
matters that the NAC considers, it prepares a proposed written 
decision, which becomes final FINRA action if the Board does not 
call the matter for review. See Notice, supra note 3.
    \8\ See FINRA Regulation By-Laws, Article V (National 
Adjudicatory Council), Section 5.2(a) (Number of Members and 
Qualifications).
    \9\ Id. A ``Non-Industry Member'' of the NAC includes any Public 
Member, an officer or employee of an issuer of securities listed on 
a market for which FINRA provides regulation, an officer or employee 
of an issuer of unlisted securities that are traded in the over-the-
counter market, or any individual who would not otherwise fall 
within the definition of an Industry Member. See FINRA Regulation 
By-Laws, Article I (Definitions), paragraph (ee). A ``Public 
Member'' generally is a Non-Industry Member who has no material 
business relationship with a broker or dealer or a self-regulatory 
organization registered under the Act. See FINRA Regulation By-Laws, 
Article I (Definitions), paragraph (hh). An ``Industry Member'' 
generally includes a person who is or served in the prior year as an 
officer, director, employee or controlling person of a broker-
dealer; is an officer, director or employee of an entity that owns a 
material equity interest in a broker-dealer; owns personally a 
material equity interest in a broker-dealer; provides professional 
services to broker-dealers, or to a director, officer, or employee 
of a broker-dealer in their professional capacity, where the 
revenues from such services meet material thresholds; or is or 
served in the prior year as a consultant, employee or provider of 
professional services to a self-regulatory organization registered 
under the Act. See FINRA Regulation By-Laws, Article I 
(Definitions), paragraph (x).
    \10\ See FINRA Regulation By-Laws, Article V (National 
Adjudicatory Council), Section 5.2(a) (Number of Members and 
Qualifications).
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    The FINRA Board appoints the NAC and its members.\11\ The FINRA 
Board appoints Non-Industry Members and at-large Industry Members from 
candidates recommended by the Nominating Committee. The FINRA Board 
also appoints Small Firm, Mid-Size Firm and Large Firm NAC Members, 
either from candidates recommended by the Nominating Committee, or in 
the event of a contested election for a Small Firm, Mid-Size Firm or 
Large Firm NAC Member vacancy, the candidate who is elected by FINRA 
members based on their vote for a candidate.\12\ The Small Firm, Mid-
Size Firm or Large Firm NAC Member candidate receiving the largest 
number of votes from firms of corresponding size is declared the 
nominee, and the Nominating Committee sends a written certification of 
the results to the FINRA Board and nominates such candidate for 
appointment to the NAC.\13\
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    \11\ See FINRA Regulation By-Laws, Article V (National 
Adjudicatory Council), Section 5.3 (Appointments).
    \12\ Id.
    \13\ See FINRA Regulation By-Laws, Article VI (Selection of 
Small Firm, Mid-Size Firm and Large Firm Industry Members of the 
National Adjudicatory Council), Section 6.13 (Certification of 
Nomination). The FINRA Board is required to appoint to the NAC the 
candidate who receives the most votes in any contested election for 
a Small Firm, Mid-Size Firm or Large Firm NAC Member seat. See FINRA 
Regulation By-Laws Article V (National Adjudicatory Council), 
Section 5.5 (Rejection of Nominating Committee Nominee).
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    The proposed rule change amends the FINRA Regulation By-Laws in 
three ways. First, it amends Section 5.2 of the FINRA Regulation By-
Laws to expand the size of the NAC from fourteen members to fifteen 
members and require that the NAC have more Non-Industry Members, 
including at least three Public Members, than Industry Members. 
Accordingly, FINRA would add one Non-Industry Member seat to the 
current 14-member committee.
    Second, the proposed rule change lengthens the term of office of 
future NAC members by one year, from three to four years.\14\ In 
addition, the NAC would be divided into four classes, rather than the 
current three, that are as equal in number as feasible.\15\
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    \14\ See Proposed FINRA Regulation By-Laws, Article V (National 
Adjudicatory Council), Section 5.6(a) and (c) (Term of Office). 
FINRA stated that the proposed rule change would not alter or extend 
the term of any NAC member serving currently; the rule change would 
apply prospectively.
    \15\ See Proposed FINRA Regulation By-Laws, Article V (National 
Adjudicatory Council), Section 5.6(b) (Term of Office). The proposed 
rule change also amends Section 5.6(a) of the FINRA Regulation By-
Laws to provide a three-year transitional period during which the 
FINRA Board may appoint new NAC members to terms of office less than 
four years to achieve the staggering necessary to divide the NAC 
into four classes. FINRA anticipates that, beginning in January 
2017, and ending in December 2019, new NAC members would be 
appointed to terms of either three years or four years to achieve 
the result of a NAC that is divided into four classes, with each NAC 
member serving a term of four years. The proposed rule change also 
makes a conforming amendment to Section 5.6(b) of the FINRA 
Regulation By-Laws to delete obsolete text related to a prior rule 
change that replaced region-based Industry NAC members with Industry 
members that represent FINRA member firms of various sizes. See 
Securities Exchange Act Release No. 58909 (November 6, 2008), 73 FR 
68467 (November 18, 2008) (Order Approving File No. SR-FINRA-2008-
046).
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    Finally, the proposed rule change streamlines the NAC election 
process and aligns it with the process currently used for elections 
involving the FINRA District Committees. The proposed rule change 
amends Section 6.7 of the FINRA Regulation By-Laws by deleting the term 
``envelope'' and adding language to permit ballots to be delivered by 
additional means.\16\ The proposed rule change aligns the ballot 
preparation process in NAC elections with that used in FINRA District 
Committee elections and allows FINRA members to vote using online and 
telephonic methods in addition to paper ballots.\17\
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    \16\ The proposed rule change would also make a conforming 
amendment to Section 6.9 of the FINRA Regulation By-Laws concerning 
ballots that are returned as undelivered.
    \17\ See FINRA Regulation By-Laws, Article VIII (District 
Committees), Section 8.11 (Ballots).
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    The proposed rule change also amends Section 6.10 of the FINRA 
Regulation By-Laws to simplify the tabulation of ballots by the 
Independent Agent, by eliminating the provision in Section 6.10 of the 
FINRA Regulation By-Laws that permits NAC candidates and their 
representatives to observe the Independent Agent's accounting of 
ballots in contested NAC elections. The proposed rule change would 
align the ballot counting process used in NAC elections with the 
process used in FINRA District Committee elections, which does not 
provide candidates the ability to be present while the Independent 
Agent opens and counts the ballots.\18\ The proposed rule change will 
thus expedite the accounting process and permit the Secretary of FINRA 
to notify the candidates more quickly of NAC election results.
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    \18\ See FINRA Regulation By-Laws, Article VIII (District 
Committees), Section 8.14 (General Procedures for Qualification and 
Accounting of Ballots). According to FINRA, the opportunity to 
observe the Independent Agent's qualification and accounting of 
ballots was rarely used by NAC candidates and provided candidates no 
additional grounds for recourse. Candidates and their 
representatives are not allowed to see the vote of any FINRA member 
and the final determination of the qualification of a ballot rests 
with the Secretary of the Corporation. See FINRA Regulation By-Laws, 
Article VI (Selection of Small Firm, Mid-Size Firm and Large Firm 
Industry Members of the National Adjudicatory Council), Section 6.10 
(General Procedures for Qualification and Accounting of Ballots). 
FINRA noted that the Secretary of the Corporation must still certify 
election results. See FINRA Regulation By-Laws, Article VI 
(Selection of Small Firm, Mid-Size Firm and Large Firm Industry 
Members of the National Adjudicatory Council), Section 6.13 
(Certification of Nomination).
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III. Summary of Comment Letters and FINRA's Response

    One commenter supported the proposed rule change and believed that 
expanding the size of the NAC and requiring that the number of Non-
Industry Members exceed the number of Industry Members would ``clearly 
advance the public interest and protect investors. . . .'' \19\ Two 
commenters generally supported the proposed rule change, but believed 
that FINRA should increase the number of Public Members on the NAC 
instead of adding an additional Non-Industry Member to the NAC.\20\ 
Finally, one commenter expressed concerns about modifying the 
composition of the NAC and lengthening the term of office of future NAC 
members.\21\
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    \19\ See Caruso Letter (recommending that the proposed rule 
change be approved on an expedited basis).
    \20\ See Berman Letter and PIABA Letter.
    \21\ See FSI Letter.
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A. Composition of the NAC

    Two commenters suggested that FINRA increase the number of Public 
Members on the NAC.\22\ Specifically, one commenter expressed concern 
that while altering the NAC's composition to include a majority of Non-
Industry Members would ``enhance its reputation for impartiality and 
reduce the possibility of deadlock[,]''persons with significant 
industry connections may qualify as Non-Industry Members.\23\ 
Similarly, another commenter believed that issuers and employees of 
issuers who would be categorized as Non-Industry Members ``may be more 
closely aligned with Industry Members under certain circumstances.'' 
\24\ One commenter, however, raised concerns about modifying the 
composition of the

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NAC.\25\ This commenter believed that the current composition of the 
NAC achieves a more balanced perspective and that increasing the number 
of Non-Industry Members on the NAC could diminish expertise on the NAC.
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    \22\ See Berman Letter and PIABA Letter.
    \23\ See Berman Letter.
    \24\ See PIABA Letter.
    \25\ See FSI Letter.
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    In its response, FINRA noted that the current and proposed FINRA 
Regulation By-Laws do not limit the ability of the Board to appoint 
more than three Public Members to the NAC.\26\ However, FINRA believed 
that explicitly increasing the number of Non-Industry Members that must 
also be Public Members would unnecessarily restrict FINRA's flexibility 
to appoint to the NAC a diversity of Non-Industry Members and Public 
Members that serve best, based on the pool of potential candidates, to 
strengthen the quality of the NAC and its deliberations and decisions. 
Further, with respect to concerns regarding Non-Industry Members 
aligning with Industry Members because of their connections to the 
securities industry, FINRA made clear that the term Non-Industry Member 
explicitly excludes any individual that would otherwise fall within the 
definition of an Industry Member \27\ and that the proposed rule change 
is similar to the current FINRA By-Laws that require the number of 
public governors that serve on the Board to exceed the number of 
industry governors.\28\
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    \26\ See FINRA Letter.
    \27\ See FINRA Letter (citing to FINRA Regulation By-Laws, 
Article I (Definitions), paragraph (ee) (defining Non-Industry 
Member)).
    \28\ According to FINRA, while the terms Non-Industry Member and 
Public Governor are not identical, they are comparable. See FINRA 
Letter.
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    In response to the commenter's concern that increasing the number 
of Non-Industry Members may diminish the NAC's balanced perspective and 
expertise, FINRA noted that the proposed rule change still maintains 
FINRA's custom of ``substantial industry participation in the NAC's 
adjudication of disciplinary and other matters.'' Further, FINRA 
represented that it is committed to appointing Non-Industry Members 
that are both highly qualified and provide unique perspectives in NAC 
deliberations, including expertise in a variety of subjects and issues 
important to the matters the NAC considers, such as the federal 
securities laws, just and equitable principals of trade, best 
professional practices, and corporate governance and compliance.

B. Terms of Office for NAC Members

    One commenter explicitly supported extending the terms of NAC 
members from three to four years.\29\ This commenter believed that the 
annual turnover of NAC members compromised the NAC's effectiveness and 
that unseasoned members lacked the same institutional knowledge as 
members that have spent a more significant amount of time on the 
NAC.\30\ However, another commenter raised concerns about extending 
terms on the NAC.\31\ This commenter, while recognizing the benefit of 
extending member terms to four years, believed that the current three-
year term allows for a rolling board with a variety of views. 
Accordingly, this commenter suggested that FINRA amend its proposal to 
re-evaluate the proposed four-year term at a future date.
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    \29\ See Berman Letter.
    \30\ See Berman Letter.
    \31\ See FSI Letter.
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    In its response, FINRA noted that the proposed rule change would 
maintain the current NAC member term limit, which generally prohibits 
NAC members from serving consecutive terms, and staggered terms. 
According to FINRA, this should allow a ``regular infusion of fresh 
ideas and knowledge and generally serve the goal of invigorating NAC 
deliberations'' with the composition of the NAC changing each year, 
while allowing NAC members to be fully productive for a longer term. 
Further, with respect to the commenter's suggestion to re-evaluate the 
four-year term at a future date, FINRA noted that the NAC's decisions 
are generally subject to discretionary review by the FINRA Board of 
Governors. As a result, the FINRA Board of Governors is ``well placed 
to conduct an ongoing evaluation of the NAC's effectiveness and the 
quality of its decision making'' and therefore, amending the proposed 
rule change to establish a date for reevaluating the effectiveness of 
the longer member terms is unnecessary.

C. NAC Selection Process

    One commenter believed that the revised selection process for 
contested elections would make the process more efficient and allow for 
electronic balloting.\32\
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    \32\ See Berman Letter.
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IV. Discussion and Commission Findings

    After carefully considering the proposal, the comments submitted, 
and FINRA's response, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder that are applicable to a national securities 
association.\33\ Specifically, the Commission finds that the proposed 
rule change is consistent with Sections 15A(b)(4), 15A(b)(6) and 
15A(b)(8) of the Act, \34\ which require, among other things, that 
FINRA rules assure a fair representation of its members in the 
administration of its affairs; are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest; and provide a fair procedure for disciplining of 
members and persons associated with members.
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    \33\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \34\ 15 U.S.C. 78o-3(b)(4), (b)(6) and (b)(8).
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    The Commission believes that FINRA's proposal to add one Non-
Industry Member to the NAC should enhance the independence of the NAC 
and continue to ensure that a diversity of expertise, experiences and 
views are represented on the NAC. With respect to commenters' 
suggestion that FINRA should increase the number of Public Members on 
the NAC,\35\ the Commission notes that under the proposed rule change 
FINRA still may appoint more than three Public Members to the NAC,\36\ 
but retains flexibility to appoint an additional Non-Industry Member or 
Public Member. According to FINRA, requiring that the Non-Industry 
Member be a Public Member would restrict its ability to appoint members 
that serve best, ``based on the pool of potential candidates, to 
strengthen the quality of the NAC as an adjudicatory body and its 
deliberations and decisions.'' \37\ Further, with respect to concerns 
that the current composition of the NAC provides a more balanced 
perspective and expertise,\38\ FINRA has represented that it will 
continue to appoint Non-Industry Members that are both highly qualified 
and provide unique perspectives and expertise in NAC deliberations.\39\ 
Moreover, while Non-Industry Members would exceed the number of 
Industry Members, seven

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of the fifteen NAC members would continue to be Industry Members, 
including two Small Firm NAC Members, one Mid-Size Firm NAC Member, two 
Large Firm NAC Members, and two at-large Industry Members.\40\ 
Accordingly, the Commission believes that the proposed rule change 
continues to allow for substantial industry participation, while 
enhancing the overall independence of the NAC.
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    \35\ See Berman Letter and PIABA Letter.
    \36\ See current and proposed FINRA Regulation By-Laws, Article 
V (National Adjudicatory Council), Section 5.2(a) (Number of Members 
and Qualifications) (stating that the National Adjudicatory Council 
shall consist of at least three Public Members).
    \37\ See FINRA Letter.
    \38\ See FSI Letter.
    \39\ See FINRA Letter. In the past, Non-Industry Members have 
included professors of law, finance, and business; current and 
former public pension and retirement system advisers; and leaders of 
independent, non-profit organizations that provide educational and 
outreach programs to issuers and investors. Id.
    \40\ See current and proposed FINRA Regulation By-Laws, Article 
V (National Adjudicatory Council), Section 5.2(a) (Number of Members 
and Qualifications).
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    The Commission also believes it is appropriate for FINRA to 
increase the term of NAC members from three to four years. While one 
commenter raised concerns about extending member terms,\41\ the 
Commission believes that the proposed rule change will allow NAC 
members to spend more time serving and being fully productive after 
gaining experience on the NAC. At the same time, the Commission 
believes the current term limits, staggered terms, and composition of 
the NAC should continue to provide the NAC with varied perspectives and 
views.
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    \41\ See FSI Letter.
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    The Commission also believes that the proposed changes to the NAC 
selection process to modernize and streamline the process and to align 
it with the process used in FINRA District Committee elections are 
appropriate.\42\ The proposed rule change would allow ballots to be 
delivered and voted by means other than the mail and further simplify 
the tabulation process by eliminating the provision that allowed NAC 
candidates and their representatives to observe the Independent Agent's 
accounting of ballots in a contested election. FINRA stated that 
candidates rarely opted to observe the Independent Agent and observing 
the Independent Agent did not provide candidates additional grounds for 
recourse. NAC candidates and their representatives were not allowed to 
see the vote of any FINRA member and the final determination of the 
qualification of a ballot rested with the Secretary of FINRA.
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    \42\ See FINRA Regulation By-Laws, Article VIII (District 
Committees), Sections 8.11 (Ballots), 8.13 (Ballots Returned as 
Undelivered), and 8.14 (General Procedures for Qualification and 
Accounting of Ballots).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\43\ that the proposed rule change (FINRA-2016-014) be, and it 
hereby is approved.
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    \43\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\44\
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    \44\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-14837 Filed 6-22-16; 8:45 am]
 BILLING CODE 8011-01-P