[Federal Register Volume 64, Number 198 (Thursday, October 14, 1999)]
[Notices]
[Pages 55793-55796]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-26793]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41971; File No. SR-NASD-99-21]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change by the National Association of Securities Dealers, Inc. To 
Create a Dispute Resolution Subsidiary

September 30, 1999.
    On April 26, 1999, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly owned regulatory 
subsidiary, NASD Regulation, Inc. (``NASD Regulation''), submitted to 
the Securities and Exchange Commission (``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 create a 
dispute resolution subsidiary. The proposed rule change was published 
for comment in the Federal Register on June 17, 1999.\3\ The Commission 
received one comment letter on the proposal from the Securities 
Industry Association (``SIA'').\4\ This order approves the proposal.
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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. 41510 (June 10, 
1999), 64 FR 32575.
    \4\ Letter from Stephen G. Sneeringer, Chairman of the 
Arbitration Committee, SIA, to Jonathan G. Katz, Secretary, 
Commission, dated July 8, 1999 (``SIA Letter'').
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I. Description of the Proposal

    The Association is proposing (i) to create a dispute resolution 
subsidiary, NASD Dispute Resolution, Inc. (``NASD Dispute 
Resolution''), to handle dispute resolution programs; (ii) to adopt by-
laws for the subsidiary; and (iii) to make conforming amendments to the 
Plan of Allocation and Delegation of Functions by NASD to Subsidiaries 
(``Delegation Plan''), the NASD Regulation By-Laws, and the Rules of 
the Association.

A. Background

    The Association's arbitration and mediation programs were operated 
by the NASD Arbitration Department until 1996, when those functions 
were moved to NASD Regulation following a corporate reorganization. 
This reorganization in part grew out of recommendations of a Select 
Committee formed by the NASD and made up of individuals with 
significant experience in the securities industry and NASD governance 
(``the Rudman Committee'').\5\ The Rudman Committee reviewed the 
Association's arbitration and mediation programs from December 1994 
through August 1995. The Rudman Report was issued in September 1995.
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    \5\ Report of the NASD Select Committee on Structure and 
Governance to the NASD Board of Governors (September 1995) (``Rudman 
Report'').
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    In September 1994, the NASD established the Arbitration Policy Task 
Force, headed by David S. Ruder, former Chairman of the SEC (``the 
Ruder Task Force''), to study NAD arbitration and recommend 
improvements. The Ruder Task Force, composed of eight persons with 
various backgrounds in the area of securities arbitration, met from the 
Fall of 1994 to January 1996, when its Report was issued.\6\
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    \6\ Report of the Arbitration Policy Task force to the Board of 
Governors National Association of Securities Dealers, Inc. (January 
1996) (``Ruder Report'').
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    Both the Rudman Committee and the Ruder Task Force made 
recommendations that affected the arbitration program. The Rudman 
Committee recommended that the NASD reorganize as a parent corporation 
with two relatively autonomous and strong operating subsidiaries, 
independent of one another. The resulting enterprise would consist of 
NASD, Inc., as parent, The Nasdaq Stock Market, Inc. (``Nasdaq'') as

[[Page 55794]]

one subsidiary to operate Nasdaq, and a new subsidiary, NASD 
Regulation, Inc., to regulate the broker-dealer members of the NASD.\7\ 
The Ruder Report recommended that the dispute resolution program be 
housed either in the parent or in NASD Regulation.\8\ The Arbitration 
Department was placed in NASD Regulation in early 1996 based on the 
recommendation of the Rudman Committee,\9\ and the name of the 
department was changed to the Office of Dispute Resolution (``ODR'') 
shortly thereafter, to reflect the full range of dispute resolution 
mechanisms.
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    \7\ Rudman Report at R-8.
    \8\ Ruder Report at 151-52.
    \9\ Rudman Report at R-8.
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    The NASD believes that ODR has established credibility as a neutral 
forum that is fair to all parties and has gained acceptance by investor 
groups. However, because there are significant differences between the 
disciplinary role of NASD Regulation and the sponsorship of a neutral 
forum for the resolution of dispute between members, associated 
persons, and customers, the NASD believes that creation of a separate 
dispute resolution entity will further strengthen the independence and 
credibility of its arbitration and mediation functions. A new dispute 
resolution subsidiary should benefit from the perception that it is 
separate and distinct from other NASD entities. The new subsidiary will 
be subject to the same SEC oversight as other parts of the NASD 
enterprise, which includes regular inspections by the Commission and 
the need to file all by-laws and rule changes with the SEC. In 
addition, the new subsidiary will remain subject to inspections by the 
General Accounting Office (``GAO''), which performs audits at the 
request of Congress.
    The NASD proposes to call the new subsidiary NASD Dispute 
Resolution, Inc. Together with NASD Regulation, the two subsidiaries 
will form the NASD Regulatory and Dispute Resolution Group. Both the 
NASD directly, and NASD Regulation, indirectly, will be responsible for 
the actions of NASD Dispute Resolution. Because NASD Dispute Resolution 
performs its functions through authority delegated by the NASD, the 
NASD is responsible for proper performance of such functions. 
Indirectly, NASD Regulation will be responsible for enforcing 
compliance with decisions rendered by NASD Dispute Resolution 
concerning NASD members.\10\
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    \10\ See Section A.1.f. of the Delegation Plan.
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    Staffing for NASD Dispute Resolution will be the same as ODR, 
except for the creation of a President position. Certain additional 
executive positions, if necessary, may be created as well. Many 
functions of the new subsidiary, such as human resources, legal, 
finance, communications, administrative services, and technology will 
be shared with the NASD and other subsidiaries to avoid duplication. 
The new subsidiary will be charged for the cost of those functions as 
it presently is.
    Funding for the new subsidiary will be handled in much the same way 
as presently handled for ODR, which is not self supporting. Fees 
received from parties who use the arbitration and mediation programs 
are not sufficient to fund the Office's regular actitivies. Rather, as 
a part of NASD Regulation, ODR shares in the revenue stream of the NASD 
and its affiliated entities, which includes revenue derived from member 
assessments, various fees and charges, disciplinary fines, and other 
sources of income. In return, ODR is charged for services that it 
receives from the other corporations in the enterprise as described 
above. Apart from accounting changes to reflect the new subsidiary's 
status, the funding process for the new subsidiary will be the same as 
that for ODR. ODR employees will continue in the same positions in the 
new subsidiary, and the physical offices will not move.
    The NASD proposes a five-person Board for NASD Dispute Resolution, 
consisting of three non-industry and two industry directors, as those 
terms are defined in Article I of the proposed By-Laws. The Chief 
Executive Officer of the NASD will be an ex-officio non-voting member 
of the Board. The non-industry directors would include at least two 
persons who also are members of the NASD Board of Governors (``NASD 
Board''), and an additional person knowledgeable in the dispute 
resolution field. At least one of the non-industry directors also will 
qualify as a public director, as defined in the By-Laws. One industry 
director would be a member of the NASD Board; the other would be the 
President of the new subsidiary. The NASD Board would elect the 
directors, as is done for the boards of the other subsidiaries.
    The procedures currently in place for disciplining members and 
associated persons for noncompliance with arbitration awards will be 
largely the same. The Code of Arbitration Procedure (``Code''), in IM-
10100, provides that the failure of a member or associated person to 
comply with an arbitration award obtained in connection with an 
arbitration submitted for disposition pursuant to the procedures 
specified by the NASD, other self-regulatory organizations, or the 
American Arbitration/Association \11\ may be deemed conduct 
inconsistent with just and equitable principles of trade and a 
violation of NASD Rule 2110. This language presently applies to awards 
obtained in the NASD Regulation forum, because that forum applies rules 
and procedures that are ultimately approved by the NASD. This will also 
be the case for NASD Dispute Resolution. Enforcement of the Code will 
continue to be handled by NASD Regulation.
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    \11\ The NASD Regulation Board of Directors recently approved an 
amendment to this Interpretive Material that would add, ``or other 
dispute resolution forum selected by the parties.'' See Securities 
Exchange Act Release No. 41339 (April 28, 1999), 64 FR 23887 (May 4, 
1999). This proposal was filed as a non-controversial filing. The 
NASD designated May 17, 1999 as the effective date of the proposal.
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    As is the case with actions by NASD Regulation, actions by the NASD 
Dispute Resolution Board may be referred by that board to the NASD 
Board, or reviewed by the NASD Board, as provided in the proposed 
amendments to the Delegation Plan.\12\ Thus, the rules of NASD Dispute 
Resolution will be the rules of the Association, just as rules approved 
currently by the other subsidiaries and subject to NASD Board review 
are deemed to be NASD rules. NASD Regulation has formed a working group 
with representatives from various departments to ensure a smooth 
transition.
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    \12\ the Delegation Plan was amended in 1997, together with 
related By-Laws changes designed to allow the NASD Board to take 
action on its own initiative rather than waiting for a subsidiary to 
act on the matter. See Securities Exchange Act Release No. 39326 
(Nov. 14, 1997), 62 FR 62385 (Nov. 21, 1997).
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B. Description of Proposed Amendments

    The Association proposes to amend the Delegation Plan to add 
references to the new subsidiary and to move the arbitration and 
mediation functions from NASD Regulation to NASD Dispute Resolution. 
Therefore, references to the delegations of authority to the 
subsidiaries and the rulemaking decisions of the subsidiaries have been 
amended to include references to NASD Dispute Resolution. As is the 
case for NASD Regulation and Nasdaq, actions of the new subsidiary 
Board will be subject to review by the NASD Board, and rule filings 
will be made by the new subsidiary on behalf of the NASD.
    The description of the National Arbitration and Mediation Committee 
(``NAMC'') in the Delegation Plan has been moved from the section 
delegating authority to NASD Regulation to a new NASD Dispute 
Resolution section. A

[[Page 55795]]

change has been made in the NAMC member balancing requirement to 
provide more flexibility while maintaining at least 50% non-industry 
membership. The Delegation Plan currently provides that NAMC membership 
shall be equally balanced between industry and non-industry members. It 
may be desirable, however, to have an odd number of members on the NAMC 
to avoid tie votes. Therefore, the provision has been amended to state 
that the NAMC shall have at least 50% non-industry members. This 
provides additional flexibility while maintaining a minimum of half 
non-industry members, in accordance with the spirit of the Delegation 
Plan.
    The Association proposes to amend the NASD Regulation By-Laws to 
add references to NASD Dispute Resolution in the definitions 
sections.\13\
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    \13\ The NASD also intends to review the NASD and Nasdaq By-Laws 
and other corporate governance documents to identify other 
appropriate amendments recognizing the formation of NASD Dispute 
Resolution.
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    Rule 0120(b) will be amended to clarify that the term 
``Association'' collectively means the NASD and its subsidiaries that 
are considered part of the self-regulatory organization: that is, the 
NASD, NASD Regulation, Nasdaq, and NASD Dispute Resolution.
    Rule 10102(a) of the Code of Arbitration procedure will be amended 
to clarify that the new NASD Dispute Resolution Board will appoint 
members of the NAMC and name its chair. In addition, Rule 10102(a) will 
be amended to replace the phrase ``a pool of arbitrators'' with the 
more accurate phrase ``rosters of neutrals,'' since the current rosters 
include both arbitrators and mediators (collectively referred to as 
``neutrals'').
    Rule 10102(b) will be amended to conform to current practice, in 
which the NAMC recommend to the Board certain rules and procedures to 
govern the conduct of arbitration and mediation matters, and does not 
unilaterally make such changes. The rule currently authorizes the NAMC 
to establish these rules and procedures. In addition, the phrase ``NASD 
Dispute Resolution'' has been added before ``Board'' to clarify that 
recommendations will be made to that Board. As noted above, actions of 
the new subsidiary board will be subject to review by the NASD Board.
    Rule 10401 will be amended to replace the phrase ``by the 
Association'' with regard to designation of the Director of Mediation 
and replace it with ``by the NASD Dispute Resolution Board,'' and to 
delete ``Association's'' as a modifier of ``National Arbitration and 
Mediation Committee.'' Although the NASD and its subsidiaries are 
collectively referred to as the Association for self-regulatory 
purposes, the use of ``Association'' in this Rule may cause confusion 
in light of the new corporate structure and serves no useful purpose in 
the Rule. The term ``of Arbitration'' will be added after one instance 
of the word ``Director'' to distinguish it from the Director of 
Mediation. In addition, the reference to the ``Board of Governors'' has 
been changed to ``NASD Dispute Resolution Board'' to reflect the new 
structure.
    Rule 10404 will be amended to change the term ``NASD'' to 
``Association'' to be more inclusive in this instance because, as 
described above, the term ``Association'' refers to the entire self-
regulatory organization including subsidiaries.
    The proposed NASD Dispute Resolution By-Laws are modeled after 
those of NASD Regulation, with certain modifications, described below, 
appropriate to the particular functions of NASD Dispute Resolution. For 
example, NASD Dispute Resolution will not require that a committee 
other than the NAMC review all rulemaking proposals. Standard 
provisions allowing for the appointment of an Executive Committee and a 
Finance committee have been included for flexibility, although it is 
not immediately expected that such committees will be needed.
    Proposed Article IV, Section 4.2 sets the number of Board members 
at five to eight although, as stated above, the intention initially is 
to have only five Board members. In addition, the Chief Executive 
Officer of the NASD will be an ex-officio non-voting member of the 
Board. Proposed Section 4.3(a) provides that the number of non-industry 
directors shall equal or exceed the number of industry directors plus 
the President. This means that the President is treated as an industry 
director for this purpose. The other industry director and at least two 
of the non-industry directors also will be sitting members of the NASD 
Board. This overlapping membership provides stability and uniformity 
among the corporations. At least one of the non-industry directors also 
will qualify as a public director. The proposed By-Laws define ``Public 
Director'' as a director who has no material business relationship with 
a broker or dealer or the NASD, NASD Regulation, Nasdaq, or NASD 
Dispute Resolution. The By-Laws define ``Non-Industry Director'' as a 
director (excluding the President) who is (1) a public director or 
public committee member; (2) an officer or employee of an issuer of 
securities listed on Nasdaq or Amex, or traded in the over-the-counter 
market; or (3) any other individual who would not be an industry 
director or industry committee member.
    A minor modification was made to the standard terminology in 
Section 4.13(h) to clarify that the Board may appoint a non-director to 
a committee, because this power is implied but not specifically stated 
in the preceding paragraphs of Section 4.13.

II. Comments

    The Commission received one comment letter from the SIA,\14\ which 
opposed the proposed rule change. The SIA disagreed with (i) the 
proposed composition of the NASD Dispute Resolution Board; (ii) the 
proposed composition of the NAMC; and (iii) the manner in which fees 
will be imposed by NASD Dispute Resolution.
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    \14\ See supra, note 4.
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    The SIA had three concerns about the composition of the NASD 
Dispute Resolution Board. First the SIA stated that industry and non-
industry representation should be equal. Second, the SIA noted that it 
is inappropriate to consider the president of NASD Dispute Resolution 
as an industry representative. Third, the SIA stated that the proposed 
compositional breakdown might permit the NASD Dispute Resolution Board 
to be dominated by claimants' lawyers. The SIA recommended that the 
Commission exclude from the definition of Non-Industry ``anyone who 
provides professional legal services to investor-claimants and whose 
revenues in that regard constitute more than 20% of his or her gross 
annual revenue.'' \15\
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    \15\ SIA Letter at 4.
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    Similarly, the SIA expressed concern about the proposed composition 
of the NAMC. It stated its position that industry and non-industry 
representation on the NAMC should be equal rather than at least 50 
percent non-industry. The SIA stated that the ``amorphous concern that 
they may be a tie vote * * * does not outweigh the more paramount 
concern that the representation on the NAMC be truly balanced between 
Industry and Non-Industry representatives.'' \16\
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    \16\ SIA Letter at 4-5.
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    In addition to the composition of the NAMC and the NASD Dispute 
Resolution Board, the SIA commented on the manner in which fees will be 
imposed under the proposed rule change. The SIA objected to the 
dichotomy between fees affecting members and those affecting non-
members. Under the proposed rule change, the NASD Board must ratify any 
rule change adopted by the NASD

[[Page 55796]]

Dispute Resolution Board that imposes fees or other charges on person 
or entities other than NASD members. Rule changes that impose fees on 
NASD members do not require NASD Board ratification. The SIA stated 
that industry participants ``should have the opportunity to participate 
in critical decisions that will impact their business and their bottom 
line--such as fee increases related to the arbitration system.'' \17\
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    \17\ SIA Letter at 5.
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    NASD Regulation responded to the SIA's concerns about the proposed 
composition of the NASD Dispute Resolution Board, the proposed 
composition of the NAMC, and the manner in which fees will be imposed 
by NASD Dispute Resolution.\18\ First, with respect to the composition 
of the NASD Dispute Resolution Board, NASD Regulation noted that this 
proposal is consistent with NASD Regulation's bylaws, which require a 
majority of non-industry members on its Board and its President and 
Nasdaq's President are also counted as industry participants for 
compositional and quorum requirements.\19\ Second, with respect to the 
composition of the NAMC, NASD Regulation noted that the NAMC's 
recommendations are only advisory and that rule changes and major 
policy changes must be presented to the NASD Dispute Resolution Board 
for final approval.\20\ Third, with respect to NASD Dispute 
Resolution's authority to impose fees on NASD members without prior 
review and ratification by the NASD Board, NASD Regulation noted that 
fee proposals must be submitted for Commission review and that the NASD 
may, on its own initiative, review any action of its subsidiaries.\21\
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    \18\ Letter from Jean I. Feeney, Assistant General Counsel, NASD 
Regulation, to Richard C. Strasser, Assistant Director, Commission, 
dated August 11, 1999.
    \19\ Id. at 2.
    \20\ Id. at 4.
    \21\ Id.
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with section 15A(b) of the Act \22\ in general and furthers the 
objectives of section 15A(b)(6) \23\ in particular, in that it is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, and to protect 
investors and the public interest.\24\ Specifically, the Commission 
believes that separating the dispute resolution role from the 
disciplinary role of NASD Regulation will result in a more neutral and 
independent forum for the resolution of disputes between members, 
associated persons, and customers. The Commission also expects the NASD 
to ensure that NASD Dispute Resolution is adequately funded and able to 
fulfill its responsibilities.
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    \22\ 15 U.S.C. 78o-3(b).
    \23\ 15 U.S.C. 78o-3(b)(6).
    \24\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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    In its comment letter, the SIA stated that industry and non-
industry representation on the NASD Dispute Resolution Board and the 
NAMC should be equal and that the President of NASD Dispute Resolution 
should not be considered an industry representative. The Commission 
notes that NASD Dispute Resolution's Board structure is modeled after 
NASD Regulation's structure. Nasdaq also requires a majority of non-
industry directors on its Board. Moreover, the Presidents of both NASD 
Regulation and Nasdaq are counted as industry participants for board 
composition and quorum requirements. The Commission believes that it is 
reasonable to extend this structure to NASD Dispute Resolution.
    The SIA also stated that the NASD Dispute Resolution Board may 
include too many claimants' lawyers, thus permitting domination by a 
single NASD Dispute Resolution constituency. The Commission disagrees, 
noting that at least two of the non-industry directors will come from 
the NASD Board. As characterized by the SIA in its comment letter, the 
current non-industry members of the NASD Board are senior executives 
from major corporations with no particular affiliation with the 
securities industry. Moreover, if NASD Dispute Resolution has a five 
member Board, only one non-industry director may be chosen from outside 
the NASD Board. While that director should be knowledgeable in the 
dispute resolution field, the universe of potential candidates is not 
limited to claimants' lawyers. Indeed, it is likely that the remaining 
non-industry position would be filled by a practicing arbitrator, a 
mediator, or an academic. Accordingly, the Commission does not believe 
that there is an undue risk that the NASD Dispute Resolution Board will 
be dominated by an single constituency of the new subsidiary.
    The SIA also stated that the NASD Board should be required to 
ratify rule changes adopted by the NASD Dispute Resolution Board if the 
rule change imposes fees or other charges on NASD members as well as 
those affecting non-members. The Commission notes that rule changes by 
the NASD Regulation and Nasdaq Boards imposing fees or other charges on 
NASD members do not require ratification by the NASD Board. The 
Commission also notes that fee proposals must be submitted for 
Commission review under Rule 19b-4 under the Act. In addition, any 
member of the NASD Board may call an action of a subsidiary for review 
at the next NASD Board meeting following the subsidiary's action. The 
Commission believes these measures provide an adequate safeguard 
against unreasonable fees being levied against NASD members.
    Finally, the Association represents that funding for the new 
subsidiary will be handled in much the same way as funding for ODR was 
accomplished. The new subsidiary will share in the revenue stream of 
the NASD and its affiliated entities, which includes revenue derived 
from member assessments, various fees and charges, disciplinary fines, 
and other sources of income. As the new subsidiary is implemented, we 
expect the NASD to commit to ensuring that NASD Dispute Resolution 
continues to be properly funded to carry out all its responsibilities.

IV. Conclusion

    It Is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\25\ that the proposed rule change (SR-NASD-99-21) is approved.

    \25\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-26793 Filed 10-13-99; 8:45 am]
BILLING CODE 8010-01-M