[Federal Register Volume 85, Number 169 (Monday, August 31, 2020)]
[Notices]
[Pages 53888-53890]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-19061]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-89659; File No. TP 20-02]


Order Granting Exemptions From Certain Rules Related to the Sale 
and Delivery of Physical Securities Under Regulation SHO Related to 
COVID-19

August 25, 2020.

I. Introduction

    The Depository Trust & Clearing Corporation (``DTCC'') has 
intermittently suspended physical securities processing services 
provided by the Depository Trust Company (``DTC''), its subsidiary, due 
to ongoing concerns related to the effects of COVID-19.\1\ While DTCC 
has resumed limited services for new physical securities 
transactions,\2\ there are likely to be delays in settlement for the 
sales of equity securities that the seller is ``deemed to own'' 
pursuant to Rule 200(b) of Regulation SHO,\3\ and for which settlement 
is dependent on the delivery of physical certificates (``owned physical 
securities''), which may result in extended failures to deliver \4\ and 
have resulting implications for compliance with Regulation SHO under 
the Securities Exchange Act of 1934 (the ``Exchange Act'').\5\ The 
Securities Industry and Financial Markets Association (``SIFMA'') has 
requested on behalf of its member firms exemptive relief from certain 
provisions of Regulation SHO \6\ in connection with the intermittent 
suspension of physical securities processing at DTC due to ongoing 
concerns related to COVID-19.\7\
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    \1\ E.g., ``Temporary Suspension of DTC Physical Securities 
Processing as of Close of
     Business on April 8, 2020,'' Important Notice B# 13276-20 (Apr. 
8, 2020) available at https://www.dtcc.com/-/media/Files/pdf/2020/4/8/13276-20.pdf; ``Update on Temporary Suspension of DTC Physical 
Securities Processing,'' Important Notice B#13352-20 (Apr. 30, 2020) 
available at https://www.dtcc.com/-/media/Files/pdf/2020/4/30/13353-20.pdf.
    \2\ ``Coronavirus Client FAQ,'' DTCC (Aug. 4, 2020) available at 
https://www.dtcc.com/~/media/Files/PDFs/Email-Files/Client-FAQ-
Coronavirus.pdf?mkt_tok=eyJpIjoiTURFellqVXhPR0V5TVRSaiIsInQiOiJPSzFvV
E1qM0ZWTWdXR1ZzZlB3c1pNYWJmOWZUUjh1Qyt0b29sYmV4cnIwWWRXYXdWTjQrSXNaOH
pyYWQ1RlNIWVFQeGhoYTN3cDJaRFwvb1JPRGdzR2c9PSJ9. DTC has requested 
that participants only submit urgent time-sensitive transactions. 
``Partial Resumption of DTC Physical Securities Processing,'' 
Important Notice B# 13402-20 (May 14, 2020) available at https://www.dtcc.com/-/media/Files/pdf/2020/5/14/13402-20.pdf.
    \3\ 17 CFR 242.200(b).
    \4\ Specifically, failures to deliver securities may occur at 
the Continuous Net Settlement system, or ``CNS,'' which is operated 
by the National Securities Clearing Corporation (``NSCC''), a 
subsidiary of DTCC. Rule 204 of Regulation SHO applies specifically 
to failures to deliver in equity securities occurring at CNS. 17 CFR
     242.204.
    \5\ 17 CFR 242.200 et seq.
    \6\ Letter from Robert Toomey, Managing Director & Associate 
General Counsel, SIFMA, dated May 21, 2020. SIFMA stated in its 
request that the Commission granted similar exemptive relief in 2012 
in the aftermath of Hurricane Sandy. See Order Granting Exemptions 
From Certain Rules of Regulation SHO Related to Hurricane Sandy, 
Release No. 34-68419 (Dec. 12, 2012) (the ``2012 Hurricane Sandy 
Order''), available at https://www.sec.gov/rules/exorders/2012/34-68419.pdf. The 2012 Hurricane Sandy Order granted exemptions from 
certain provisions of Regulation SHO related to the inaccessibility 
of physical certificates that resulted from water damage incurred at 
DTCC's vault used as part of its Custody Service for safekeeping of 
physical certificates.
    \7\ DTCC suspended but recently resumed processing of physical 
securities. ``Partial Resumption of DTC Physical Securities 
Processing,'' Important Notice B# 13402-20 (May 14, 2020) available 
at https://www.dtcc.com/-/media/Files/pdf/2020/5/14/13402-20.pdf. 
However, based on conversations with SIFMA, we understand that 
regular processing may be intermittent during the current crisis, 
and that there may be delays in processing certain physical 
securities after DTCC resumes processing after a suspension. See, 
e.g., letter from Robert Toomey, supra note 6 (``While DTCC has 
resumed limited services in connection with processing physical 
securities . . . we believe the requested relief continues to be 
appropriate and should also provide, given the ongoing uncertainties 
in connection with the COVID-19 crisis, mechanisms that would allow 
market participants to rely on the relief should there be further 
intermittent suspensions of physical securities processing during 
this crisis period.'').
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    The Commission is providing certain exemptive relief from the 
``locate'' and close-out requirements of Regulation SHO, as described 
in more detail below, for sales of owned physical securities.

II. Regulation SHO

A. Rule 200 Marking Requirement and Rule 203 ``Locate'' Requirement

    Rule 200(g) of Regulation SHO \8\ provides that broker-dealers must 
mark all sell orders of any equity security as ``long,'' ``short,'' or 
``short exempt.'' Under Rule 200(g)(1), a broker-dealer may mark an 
order to sell ``long'' only if the seller is ``deemed to own'' the 
security being sold pursuant to paragraphs (a) through (f) of Rule 200 
and either: (1) the security to be delivered is in the physical 
possession or control of the broker-dealer; or (2) it is reasonably 
expected that the security will be in the physical possession or 
control of the broker-dealer no later than the settlement of the 
transaction.
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    \8\ 17 CFR 242.200(g).
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    Due to the intermittent inaccessibility of physical certificates at 
DTC as a result of ongoing concerns related to the effects of COVID-19, 
sell orders for owned physical securities may not qualify for ``long'' 
order marking under Rule 200(g)(1).\9\ Specifically, a broker-dealer 
may not have a reasonable expectation that such securities will be in 
the physical possession or control of the broker-dealer by the 
settlement date.\10\ Therefore, the broker-dealer would be required to 
mark such sale orders as ``short'' or, if eligible for Rule 201(c) or 
(d), ``short exempt.'' \11\
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    \9\ See Exchange Act Release No. 50103 (July 28, 2004), 69 FR 
48008, 48012, 48015 (Aug. 6, 2004) (``Regulation SHO Adopting 
Release''). As noted below, sales marked ``short'' and ``short 
exempt'' are generally subject to the Rule 203(b) locate requirement 
absent an exception.
    \10\ 17 CFR 242.200(g)(1)(ii).
    \11\ Certain sales of owned physical securities may also qualify 
under Rule 201(d)(1) to be marked ``short exempt'' provided that the 
broker-dealer executing the transaction makes the required 
determination regarding the seller's ownership of the security, and 
that the seller intends to deliver the security as soon as the 
current restrictions on delivery have been removed. 17 CFR 
242.201(d)(1).
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    Pursuant to Rule 203(b) of Regulation SHO, a broker-dealer may not 
accept a short sale order in an equity security from another person, or 
effect a short sale in an equity security for its own account, unless 
the broker-dealer has: (1) Borrowed the security, or entered into a 
bona fide arrangement to borrow the security; or (2) reasonable grounds 
to believe that the security can be borrowed so that it can be 
delivered on the date delivery is due.\12\ This requirement is known as 
the ``locate'' requirement, and must be met and

[[Page 53889]]

documented prior to effecting a short sale.\13\
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    \12\ 17 CFR 242.203(b).
    \13\ Certain exceptions to the ``locate'' requirement are 
provided under Rule 203(b)(2). See 17 CFR 242.203(b)(2).
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    The Commission provided a specific exception to the ``locate'' 
requirement, however, for sales of such securities that the person is 
``deemed to own'' pursuant to Rule 200(b) of Regulation SHO. Pursuant 
to Rule 203(b)(2)(ii), sales of such ``deemed to own'' securities are 
excepted from the ``locate'' requirement provided that the seller 
intends to deliver the securities as soon as all restrictions on 
delivery have been removed, and further provided that if the seller has 
not delivered such securities within 35 days after the trade date, the 
broker-dealer that effected the sale must borrow securities or close 
out the short position by purchasing securities of like kind and 
quantity.\14\ In adopting this exception, the Commission emphasized 
that these sales are treated as short sales solely because the seller 
is unable to deliver the security that it owns to its broker-dealer 
prior to settlement, based on circumstances outside the seller's 
control and through no fault of the seller or the broker-dealer.\15\
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    \14\ See 17 CFR 242.203(b)(2)(ii); see also Regulation SHO 
Adopting Release, 69 FR at 48015.
    \15\ See Regulation SHO Adopting Release, 69 FR at 48015; see 
also Exchange Act Release No. 61595 (Feb. 26, 2010), 75 FR 11232, 
11266 (Mar. 10, 2010).
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    SIFMA has stated in conversations with Commission staff that fail 
to deliver positions resulting directly from DTC's intermittent 
suspension of physical securities processing may persist for longer 
than the 35 day delivery requirement provided for under the Rule 
203(b)(2)(ii) exception to the locate requirement for sales of 
securities that the seller is ``deemed to own.'' Therefore, absent the 
requested exemptive relief, SIFMA stated that broker-dealers effecting 
short sales for such owned physical securities would be required to 
either comply with the Rule 203(b) locate requirement, or 
alternatively, comply with the delivery requirement under Rule 
203(b)(2)(ii) (i.e., if the seller has not delivered such security 
within 35 days after the trade date, the broker-dealer that effected 
the sale must borrow securities or close out the short position by 
purchasing securities of like kind and quantity). We believe that 
requiring compliance with the Rule 203(b) ``locate'' requirement or the 
delivery requirement under Rule 203(b)(2(ii) in spite of the 
anticipated delivery delays as a result of DTC's intermittent 
suspension of physical securities processing due to ongoing concerns 
related to COVID-19 may cause undue burdens on various market 
participants, particularly in the context of physical securities for 
which lending markets are small or non-existent. As a result, we 
believe that the temporary relief from the Rule 203(b) ``locate'' 
requirement of Regulation SHO for owned physical securities provided by 
this Exemptive Order is appropriate in the public interest and 
consistent with the protection of investors.
    Accordingly, it is ordered, pursuant to Section 36 of the Exchange 
Act,\16\ that a broker-dealer is exempt from the ``locate'' requirement 
of Rule 203(b), including the delivery requirement of Rule 
203(b)(2)(ii), with respect to a short sale order in an owned physical 
security, subject to the following conditions:\17\
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    \16\ Section 36 of the Exchange Act authorizes the Commission, 
by rule, regulation or order, to exempt, either conditionally or 
unconditionally, any person, security or transaction, or any class 
or classes of persons, securities or transactions, from any 
provision or provisions of the Exchange Act or any rule or 
regulation thereunder, to the extent that such exemption is 
necessary or appropriate in the public interest, and is consistent 
with the protection of investors. 15 U.S.C. 78mm(a).
    \17\ These conditions are designed to (1) ensure that executing 
brokers do not rely on the relief from Rule 203(b) granted in this 
Order beyond the extent to which the seller is ``deemed to own'' the 
relevant security, and (2) aid in ensuring participants' compliance 
with this Order (to the extent they choose to avail themselves of 
the relief). The relief granted in this Order applies only in the 
context of suspensions of physical securities processing resulting 
directly from ongoing concerns related to COVID-19.
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    (a) The broker-dealer determines, prior to accepting such short 
sale order from another person, or effecting such short sale for its 
own account, that the sale is a sale of an owned physical security that 
the seller is ``deemed to own'' pursuant to Rule 200 of Regulation SHO; 
\18\
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    \18\ 17 CFR 242.200.
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    (b) The broker-dealer maintains contemporaneous records reflecting 
any reliance on this Order, and makes this information available to 
Commission staff upon request; and
    (c) The broker-dealer provides notice on its website promptly upon 
its initial reliance on the Order and maintains the notice on its 
website until it ceases reliance on the Order.

B. Close-Out Requirements Under Rule 204 of Regulation SHO

    Rule 204(a) of Regulation SHO \19\ generally requires that 
participants of a registered clearing agency (``Participants'') close 
out fail to deliver positions at a registered clearing agency \20\ in 
any equity security for a sale transaction in that equity security by 
no later than the beginning of regular trading hours on the next 
settlement day after a fail to deliver resulting from a short sale 
(generally T+3), and no later than the beginning of regular trading 
hours on the third settlement day after a fail to deliver resulting 
from a long sale or a sale resulting from bona fide market making 
activities at the time of the sale (generally T+5). A close-out of a 
fail to deliver position is effected by purchasing or borrowing shares 
of like kind and quantity.
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    \19\ 17 CFR 242.204(a).
    \20\ The term ``registered clearing agency'' means a clearing 
agency, as defined in Section 3(a)(23)(A) of the Exchange Act, that 
is registered as such pursuant to Section 17A of the Exchange Act. 
See 15 U.S.C. 78c(a)(23)(A); 15 U.S.C. 78q-1. The majority of equity 
trades in the United States are cleared and settled through systems 
administered by clearing agencies registered with the Commission. 
NSCC clears and settles the majority of equity securities trades 
conducted on the exchanges and in the over-the-counter market. NSCC 
clears and settles trades through CNS, which nets the securities 
delivery and payment obligations of all of its members. See Exchange 
Act Release No. 60388 (July 27, 2009), 74 FR 38266, 38268 n.35 (July 
31, 2009) (``Rule 204 Adopting Release'').
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    Similar to the exception to the ``locate'' requirement discussed 
above, Rule 204(a)(2) provides an extended close-out timeframe (T+35) 
for fail to deliver positions resulting from a sale of a security that 
a person is ``deemed to own'' and intends to deliver as soon as all 
restrictions on delivery have been removed.\21\ Thus, fail to deliver 
positions resulting from sales of owned physical securities would 
ordinarily be eligible for the extended close-out timeframe provided by 
Rule 204(a)(2).\22\ As noted above, however, SIFMA has stated in 
discussions with the Commission staff that, due to the inaccessibility 
of the physical certificates resulting from DTC's intermittent 
suspension of physical securities processing, there may be instances in 
which sales of owned

[[Page 53890]]

physical securities may result in a CNS fail to deliver position that 
persists beyond the T+35 close-out timeframe.
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    \21\ See 17 CFR 242.204(a)(2); see also Rule 204 Adopting 
Release, 74 FR at 38277 n.141. Under Rule 204(a)(2), a Participant 
that has a fail to deliver position resulting from a sale of a 
security that a person is ``deemed to own'' pursuant to Rule 200 of 
Regulation SHO and that such person intends to deliver as soon as 
all restrictions on delivery have been removed must, by no later 
than the beginning of regular trading hours on the thirty-fifth 
consecutive calendar day following the trade date for the 
transaction, immediately close out the fail to deliver position by 
purchasing or borrowing securities of like kind and quantity.
    \22\ See Rule 204 Adopting Release, 74 FR at 38277-38278. In 
providing an extended close-out timeframe for sales of ``deemed to 
own'' securities, the Commission stated that additional time is 
warranted for these sales and such additional time would not 
undermine the goal of reducing fail to deliver positions because 
``these are sales of owned securities that cannot be delivered by 
settlement date due solely to processing delays outside the seller's 
or broker-dealer's control,'' and that ``[m]oreover, delivery will 
be made on such sales as soon as all restrictions on delivery have 
been removed.'' Id.
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    Pursuant to Rule 204(b) of Regulation SHO,\23\ if a Participant has 
not closed out a fail to deliver position in an equity security in 
accordance with Rule 204(a), the Participant and any broker-dealer from 
which the Participant receives trades for clearance and settlement, may 
not accept a short sale order in that equity security from another 
person or effect a short sale in that equity security for its own 
account, without first borrowing, or arranging to borrow, the security 
until the Participant closes out the fail to deliver position by 
purchasing securities of like kind and quantity, and that purchase has 
cleared and settled at a registered clearing agency. This requirement 
is known as the ``Penalty Box'' provision. As stated by the Commission, 
this provision is ``intended to act as an additional incentive to 
broker-dealers to deliver securities by settlement date, and to close 
out fail to deliver positions in accordance with the requirements of 
Rule 204.'' \24\ Absent relief, Participants would be required to close 
out any fail to deliver positions resulting from the sale of owned 
physical securities pursuant to Rule 204(a)(2) and, if they did not, 
would be subject to the Penalty Box provision.
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    \23\ 17 CFR 242.204(b).
    \24\ Rule 204 Adopting Release at 38275.
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    We believe that, due to DTC's intermittent suspension of physical 
securities processing, sales of owned physical securities raise policy 
considerations that warrant granting limited exemptive relief.\25\ 
Moreover, requiring compliance with the Rule 204(a)(2) close-out 
requirement may create undue burdens for Participants and other broker-
dealers for which they clear and settle trades, and we do not believe 
that subjecting Participants or other broker-dealers to the Penalty Box 
provision in this context would further the policy goal of 
incentivizing broker-dealers to deliver securities by settlement and to 
close out fail to deliver positions in accordance with Rule 204. Thus, 
we believe that the temporary relief from the close-out requirement of 
Regulation SHO provided by this Exemptive Order is appropriate in the 
public interest and consistent with the protection of investors.
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    \25\ These policy considerations are similar to those considered 
in the context of the 2012 Hurricane Sandy Order. See supra note 6.
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    Accordingly, it is further ordered, pursuant to Section 36 of the 
Exchange Act,\26\ that a Participant is exempt from the close-out 
requirement of Rule 204(a) \27\ and the Penalty Box provision of Rule 
204(b) \28\ of Regulation SHO with respect to a fail to deliver 
position resulting from the sale of an owned physical security,\29\ 
subject to the following conditions: \30\
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    \26\ See supra note 16.
    \27\ 17 CFR 242.204(a).
    \28\ 17 CFR 242.204(b).
    \29\ Rule 203(b)(3) of Regulation SHO provides that if a 
Participant has a fail to deliver position at a registered clearing 
agency in a threshold security, as defined by Rule 203(c)(6), for 
thirteen consecutive settlement days, the Participant shall 
immediately thereafter close out the fail to deliver position by 
purchasing securities of like kind and quantity. If the sale of an 
owned physical security resulted in a fail to deliver position in a 
threshold security and that fail to deliver position persisted for 
thirteen consecutive settlement days because the close-out date 
applicable under this Exemptive Order had not yet arrived, Rule 
203(b)(3) would nonetheless require the Participant to close out the 
fail to deliver position. Accordingly, Participants are exempt from 
the close-out requirements of Rule 203(b)(3) with respect to fail to 
deliver positions in threshold securities resulting from sales of 
owned physical securities, provided that the Participants close out 
the fail to deliver positions in compliance with this Exemptive 
Order. See 17 CFR 242.203(b)(3).
    \30\ These conditions are designed to (1) promote the prompt 
delivery of securities by participants as soon as practical under 
the circumstances surrounding COVID-19 without putting undue burdens 
on participants or their customers, and (2) aid in ensuring 
participants' compliance with this Order.
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    (a) The Participant must determine and document that the fail to 
deliver position resulted from a sale of an owned physical security 
\31\ that a person is ``deemed to own'' pursuant to Rule 200 of 
Regulation SHO; \32\
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    \31\ Such determination could be based, for example, on records 
indicating that the sale involves a physical certificate custodied 
at DTCC.
    \32\ 17 CFR 242.200.
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    (b) The Participant must check DTCC systems on a daily basis to 
determine when an owned physical security, the sale of which resulted 
in a fail to deliver position, is available for settlement; \33\
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    \33\ We understand based on conversations with SIFMA that 
processing for certain securities may resume prior to that for 
others. As such, this determination must be made on a security-by-
security basis. We further understand that DTC systems (including 
the Participant Browser System and the Participant Terminal System) 
enable Participants to verify their positions in physical securities 
held at DTC and issue withdrawal instructions. We understand that 
these systems permit Participants, in conjunction with the 
Participant's own books and records, to track when physical 
securities have been debited (withdrawn) and sent to the transfer 
agent and when the physical securities are available for settlement 
after they have been returned to DTC and are available for 
Participant pickup, are mailed directly to the customer, or are set 
up as a Direct Registration System account, and that Participants 
check these systems for completed status of physical certificate 
processing on a daily basis.
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    (c) The Participant must deliver the owned physical security as 
soon as possible, and in any event, must deliver the security or close 
out the fail to deliver position resulting from the sale by purchasing 
or borrowing securities of like kind and quantity by no later than the 
beginning of regular trading hours on the fourth settlement day 
following the date on which the Participant determines, in accordance 
with condition (b) above, that the owned physical security, the sale of 
which resulted in the fail to deliver position, is available for 
settlement;
    (d) The Participant's books and records must reflect that it made 
delivery of the owned physical security or closed out the fail to 
deliver position resulting from the sale within the applicable time 
period, consistent with this Exemptive Order;
    (e) The Participant must maintain contemporaneous records 
reflecting any reliance on this Order, and make this information 
available to Commission staff upon request; and
    (f) The participant provides notice on its website promptly upon 
its initial reliance on the Order and maintains the notice on its 
website until it ceases reliance on the Order.

III. Modification, Revocation, and Expiration of Exemptions

    The relief provided in this Order shall expire on December 31, 
2020. The Commission intends to continue to monitor the current 
situation. The time period for any or all of the relief may, if 
necessary, be extended with any additional conditions that are deemed 
appropriate, and the Commission may issue other relief as necessary or 
appropriate.
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    \34\ See 17 CFR 200.30-3(a)(11).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\34\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-19061 Filed 8-28-20; 8:45 am]
BILLING CODE 8011-01-P