[Federal Register Volume 63, Number 81 (Tuesday, April 28, 1998)]
[Notices]
[Pages 23317-23321]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-11169]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39893; File No. SR-NASD-98-23]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to an Amendment to the NASD's Options Position Limits Rule

April 21, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act''),\1\ notice is hereby given that on March 
10, 1998, NASD Regulation, Inc. (``NASD Regulation'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the self-regulatory organization. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation is proposing to amend Rule 2860(b) of the of the 
National Association of Securities Dealers, Inc. (``NASD'' or 
``Association'') to: (1) increase the position limits on conventional 
equity options to three times the basic position limits for 
standardized equity options on the same security; (2) disaggregate 
conventional equity options from standardized equity options and FLEX 
Equity Options for position limit purposes; and (3) provide that the 
OTC Collar Aggregation Exemption shall be available with respect to an 
entire conventional equity options position, not just that portion of 
the position that is established pursuant to the NASD's Equity Option 
Hedge Exemption. Below is the text of the proposed rule change. 
Proposed new

[[Page 23318]]

language is in italics; proposed deletions are in brackets.\2\
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    \2\ The proposed new language assumes that the proposed rule 
changes filed with the Commission in SR-NASD-98-15, on February 13, 
1998, and SR-NASD-98-02, on January 20, 1998, have been approved. 
The Commission notes that SR-NASD-98-15 was approved on March 19, 
1998, and SR-NASD-98-02 was approved on April 14, 1998. See Exchange 
Act Release Nos. 39771 (March 19, 1998), 63 FR 14743 (March 26, 
1998) (SR-NASD-98-15); 39865 (April 14, 1998) (SR-NASD-98-02).
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Rule 2860. Options
* * * * *
(b) Requirements
(2) Definitions
    The following terms shall, unless the context otherwise requires, 
have the stated meanings:
* * * * *
    (VV) Standardized Equity Option--The term ``standardized equity 
option'' means any equity options contract issued, or subject to 
issuance by, The Options Clearing Corporation that is not a FLEX Equity 
Option.
    (WW)--(AAA) Redesignated accordingly.
* * * * *
(3) Position Limits
    (A) Stock Options--Except in highly unusual circumstances and with 
the prior written approval of the Association in each instance, no 
member shall effect for any account in which such member has an 
interest, or for the account of any partner, officer, director or 
employee thereof, or for the account of any customer, an opening 
transaction through Nasdaq, the over-the-counter market or on any 
exchange in a stock option contract of any class of stock options if 
the member has reason to believe that as a result of such transaction 
the member or partner, officer, director or employee thereof, or 
customer would, acting alone or in concert with others, directly or 
indirectly, hold or control or be obligated in respect of an aggregate 
standardized equity options position in excess of:
    (i) 4,500 option contracts of the put class and the call class on 
the same side of the market covering the same underlying security, 
combining for purposes of this position limit long positions in put 
options with short positions in call options, and short positions in 
put options with long positions in call options; or
    (ii) 7,500 options contracts of the put class and the call class on 
the same side of the market covering the same underlying security, 
providing that the 7,500 contract position limit shall only be 
available for option contracts on securities which underlie or qualify 
to underlie Nasdaq or exchange-traded options qualifying under 
applicable rules for a position limit of 7,500 option contracts; or
    (iii) 10,500 option contracts of the put class and the call class 
on the same side of the market covering the same underlying security 
providing that the 10,500 contract position limit shall only be 
available for option contracts on securities which underlie or qualify 
to underlie Nasdaq or exchange-traded options qualifying under 
applicable rules for a position limit of 10,500 option contracts; or
    (iv) 20,000 options contracts of the put and the call class on the 
same side of the market covering the same underlying security, 
providing that the 20,000 contract position limit shall only be 
available for option contracts on securities which underlie or qualify 
to underlie Nasdaq or exchange-traded options qualifying under 
applicable rules for a position limit of 20,000 option contracts; or
    (v) 25,000 options contracts of the put and the call class on the 
same side of the market covering the same underlying security, 
providing that the 25,000 contract position limit shall only be 
available for option contracts on securities which underlie or qualify 
to underlie Nasdaq or exchange-traded options qualifying under 
applicable rules for a position limit of 25,000 option contracts; or
    (vi) such other number stock options contracts as may be fixed from 
time to time by the Association as the position limit for one or more 
classes or series of options provided that reasonable notice shall be 
given of each new position limit fixed by the Association.
    (vii) Equity Option Hedge Exemption
    a. The following positions, where each option contract is 
``hedged'' by 100 shares of stock or securities readily convertible 
into or economically equivalent to such stock, or, in the case of an 
adjusted option contract, the same number of shares represented by the 
adjusted contract, shall be exempted from established limits contained 
in (i) through (vi) above:
    1. long call and short stock;
    2. short call and long stock;
    3. long put and long stock.
    4. short put and short stock
    b. Except as provided [under] in subparagraph (b)(3)(A)(ix) and in 
the OTC Collar Exemption contained in subparagraph (b)(3)(A)(viii), in 
no event may the maximum allowable position, inclusive of options 
contracts hedged pursuant to the equity option position limit hedge 
exemption in subparagraph a. above, exceed three times the applicable 
position limit established in subparagraph (b)(3)(A)(i)-(v) with 
respect to standardized equity options, or subparagraph (b)(3)(A)(ix) 
with respect to conventional equity options.
    c. The Equity Option Hedge Exemption is a pilot program authorized 
by the Commission through December 31, 1999.\3\
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    \3\ The Commission notes that the NASD filed a proposed rule 
change requesting that the Equity Option Hedge Exemption pilot 
program be extended until December 31, 1999. An amendment was later 
filed, reducing the extension until December 31, 1998. The 
Commission approved the proposed rule change, as amended. See 
Exchange Act Release No. 39865 (April 14, 1998) (SR-NASD-98-02). The 
NASD will be submitting an amendment to this filing (SR-NASD-98-23), 
clarifying in the proposed rule language that the Equity Option 
Hedge Exemption pilot program has been extended only until December 
31, 1998.
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(viii) OTC With Aggregation Exemption
    a. For purposes of this paragraph (b), the term OTC collar shall 
mean a conventional equity option position comprised of short (long) 
calls and long (short) puts overlying the same security that hedge a 
corresponding long (short) position in that security.
    b. Notwithstanding the aggregation provisions for short (long) call 
positions and long (short) put positions contained in subparagraphs (i) 
through (v) above, the conventional options positions involved in a 
particular OTC collar transaction [established pursuant to the position 
limit hedge exemption in subparagraph (vii)] need not be aggregated for 
position limit purposes, provided the following conditions are 
satisfied:
    1. the conventional options can only be exercised if they are in-
the-money;
    2. neither conventional option can be sold, assigned, or 
transferred by the holder without the prior written consent of the 
writer;
    3. the conventional options must be European-style (i.e., only 
exercisable upon expiration) and expire on the same date;
    4. The strike price of the short call can never be less than the 
strike price of the long put; and
    5. neither side of any particular OTC collar transaction can be in-
the-money when that particular OTC collar is established.
    6. the size of the conventional options in excess of the applicable 
basic position limit for the options established pursuant to 
subparagraph (b)(3)(A)(ix) [(A)(i)-(v) above] must be hedged on a one-
to-one basis with the requisite long or short stock position for the 
duration of the collar, although the same long or short stock position 
can be used to hedge both legs of the collar.

[[Page 23319]]

    c. For multiple OTC collars on the same security meeting the 
conditions set forth in subparagraph b. above, all of the short (long) 
call options that are part of such collars must be aggregated and all 
of the long (short) put options that are part of such collars must be 
aggregated, but the short (long) calls need not be aggregated with the 
long (short) puts.
    d. Except as provided above in subparagraphs b. and c., in no event 
may a member fail to aggregate any conventional [or standardized] 
options contract of the put class and the call class overlying the same 
equity security on the same side on the market with conventional option 
positions established in connection with an OTC collar.
    e. Nothing in this subparagraph (viii) changes the applicable 
position limit for a particular equity security.
    (ix) For purposes of this paragraph (b), standardized equity 
options contracts of the put class and call class on the same side of 
the market overlying the same security shall not be aggregated with 
conventional equity options contracts or FLEX Equity Options contracts 
overlying the same security on the same side of the market. 
Conventional equity options contracts of the put class and call class 
on the same side of the market overlying the same security shall be 
subject to a basic position limit equal to three times the applicable 
position limit established for standardized equity options overlying 
the security pursuant to subparagraphs A(i)-(v) above and are eligible 
for the OTC Collar Exemption set forth in subparagraph A(viii) above 
and the Equity Option Hedge Exemption set forth in subparagraph A(vii) 
above.

(Footnotes omitted. No changes).
* * * * *
IM-2860-1. Position Limits
    The following examples illustrate the operation of position limits 
established by Rule 2860(b)(3) (all examples assume a position limit of 
4,500 contracts and that the options are standardized options):
    (a) Customer A, who is long 4,500 XYZ calls, may at the same time 
be short 4,500 XYZ calls, since long and short positions in the same 
class of options (i.e., in calls only, or in puts only) are on opposite 
sides of the market and are not aggregated for purposes of paragraph 
(b)(3).
    (b) Customer B, who is long 4,500 XYZ calls, may at the same time 
be long 4,500 XYZ puts. Paragraph (b)(3) does not require the 
aggregation of long call and long put (or short call and short put) 
positions, since they are on opposite sides of the market.
    (c) Customer C, who is long 1,700 XYZ calls, may not at the same 
time be short more than 2,800 XYZ puts, since the 4,500 contract limit 
applies to the aggregation of long call and short put positions in 
options covering the same underlying security. Similarly, if Customer C 
is also short 1,600 XYZ calls, he may not at the same time be long more 
than 2,900 puts, since the 4,500 contract limit applies separately to 
the aggregation of short call and long put positions in options 
covering the same underlying security.
    (d) Customer D, who is short 900,000 [450,000] shares of XYZ, may 
be long up to 13,500 [9,000] XYZ calls, since the ``hedge'' exemption 
contained in paragraph (b)(3)(A)(vii) permits Customer D to establish 
an options position up to 13,500 [9,000] contracts in size. In this 
instance, 4,500 of the 13,500 [9,000] contracts are permissible under 
the basic position limit contained in paragraph (b)(3)(A)(i) and the 
remaining 9,000 [4,500] contracts are permissible because they are 
hedged by the 900,000 [450,000] short stock position.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    NASD Rule 2860(b)(3) provides that the position limit \4\ for each 
equity option is determined according to a five-tiered system whereby 
more actively traded securities with larger public floats are subject 
to higher position limits and less actively traded stocks are subject 
to lower limits.\5\ Presently, conventional and standardized equity 
options are subject to the same position limits, and all equity options 
overlying a particular equity security on the same side of the market 
are aggregated for position limit purposes, regardless of whether the 
option is a conventional, standardized or FLEX Equity Option.\6\ On 
September 9, 1997, the Commission approved a two-year pilot program 
(``Pilot Program'') to eliminate position and exercise limits for FLEX 
Equity Options, which are traded on the American Stock Exchange, Inc. 
(``AMES''), the Chicago Board Options Exchange, Inc. (``CBOE''), and 
the Pacific Exchange, Inc. (``PCX'') (collectively ``Options 
Exchanges'').\7\ In light of the Pilot Program, NASD Regulation is 
proposing to amend its rules governing position and exercise limits for 
conventional equity options. NASD Regulation previously has filed a 
proposed rule change to eliminate position and exercise limits on FLEX 
Equity Options to make its rules consistent with the Pilot Program.\8\ 
NASD Regulation believes the proposed rule change herein is necessary 
to foster competition between the over-the-counter (``OTC'') market and 
the Options Exchanges.
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    \4\ Position limits impose a ceiling on the number of option 
contracts in each class on the same side of the market (i.e., 
aggregating long calls and short puts; or long puts and short calls) 
that can be held or written by an investor or group of investors 
acting in concert. Exercise limits restrict the number of options 
contracts that an investor or group of investors acting in concert 
can exercise within five consecutive business days. Under NASD 
Rules, exercise limits correspond to position limits, such that 
investors in options classes on the same side of the market are 
allowed to exercise, during any five consecutive business days, only 
the number of options contracts set forth as the applicable position 
limit for those options classes. See NASD Rules 2860(b)(3) and (4).
    \5\ Currently, the five tiers are for 4,500, 7,500, 10,500, 
20,000 and 25,000 contracts. NASD rules do not specifically govern 
how a specific equity option falls within one of the five position 
limit tiers. Rather, the NASD's position limit rule provides that 
the position limit established by an options exchange(s) for a 
particular equity option is the applicable position limit for 
purposes of the NASD's rule.
    \6\ Standardized options are exchange-traded options issued by 
the Options Clearing Corporation (``OCC'') that have standard terms 
with respect to strike prices, expiration dates, and the amount of 
the underlying security. A conventional option is any other option 
contract not issued, or subject to issuance by, OCC.
    \7\ See Exchange Act Release No. 39032 (September 9, 1997), 62 
FR 48683 (September 16, 1997).
    \8\ See SR-NASD-98-15. The Commission notes that SR-NASD-98-15 
was approved on March 19, 1998. See Exchange Act Release No. 39771 
(March 19, 1998), 63 FR 14743 (March 26, 1998).
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    FLEX Equity Options are exchange-traded options issued by the 
Options Clearing Corporation (``OCC'') that give investors the ability, 
within specified limits, to designate certain terms of the option 
(i.e., the exercise price, exercise style, expiration date, and option 
type). Because they are non-uniform and individually negotiated, FLEX 
Equity Options closely resemble and are

[[Page 23320]]

economically equivalent to conventional equity options. Accordingly, to 
more closely align the NASD's position limit rules for conventional 
equity options with the rules for FLEX Equity Options, NASD Regulation 
proposes to amend Rule 2860(b)(3) to provide that: (1) position limits 
on conventional equity options shall be increased to three times the 
basic position limits for standardized equity options on the same 
security; (2) conventional equity options shall be disaggregated from 
standardized equity options and FLEX Equity Options for position limit 
purposes; and (3) the OTC Collar Aggregation Exemption shall be 
available with respect to an entire conventional equity options 
position, not just that portion of the position that is established 
pursuant to the NASD's Equity Option Hedge Exemption.
    The NASD's Equity Option Hedge Exemption \9\ provides for an 
automatic exemption from equity option position limits for accounts 
that have established hedged positions on a limited one-for-one basis 
(i.e., 100 shares of stock for one option contract). Under the Equity 
Option Hedge Exemption, the largest options position that may be 
established (combining hedged and unhedged positions) may not exceed 
three times the basic position limit. The OTC Collar Aggregation 
Exemption \10\ provides that positions in conventional put and call 
options establishing OTC collars need not be aggregated for position 
limit purposes. An OTC collar transaction involves the purchase (sale) 
of a put and the sale (purchase) of a call on the same underlying 
security to hedge a long (short) stock position.
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    \9\ Rule 2860(b)(3)(A)(vii).
    \10\ Rule 2860(b)(3)(A)(viii).
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    At the present time, NASD Regulation believes that the prudent 
regulatory approach is to increase position limits on conventional 
equity options in conjunction with continued availability of the Equity 
Option Hedge Exemption and OTC Collar Aggregation Exemption. NASD 
Regulation proposes an incremental approach and in this case believes 
that increasing position limits for conventional equity options to 
three times the position limits for standardized equity options is 
appropriate. These proposed limits correspond to the position limits in 
effect for FLEX Equity Options prior to the Pilot Program.
    NASD Regulation also believes that conventional equity options 
positions should not be aggregated with standardized and FLEX Equity 
Options on the same securities for position limit purposes. 
Disaggregation of conventional and other options is necessary to give 
full effect to the proposed increase in position limits for 
conventional equity options. Without disaggregation, positions in FLEX 
Equity Option or standardized option positions would reduce or 
potentially even eliminate (in the case of FLEX Equity Options) the 
available position limits for conventional equity options.
    To illustrate how these proposed amendments would work, consider 
the following example of stock ABCD, which is subject to a position 
limit of 25,000 standardized equity option contracts. In this example, 
a market participant could establish a position of 25,000 standardized 
option contracts on ABCD and an additional 75,000 conventional option 
contracts on ABCD on the same side of the market, since conventional 
and standardized option positions would be disaggregated. In addition, 
the market participant also may have a position of any size in FLEX 
Equity Options overlying ABCD, since such FLEX Equity Options would not 
be aggregated with either the conventional equity options or 
standardized equity options overlying ABCD. Further, by taking 
advantage of the Equity Option Hedge Exemption, which permits a market 
participant to assume a hedged options position that is three times the 
otherwise applicable position limit, a market participant could 
increase the number of conventional equity options to 225,000 
contracts.
    NASD Regulation proposes to modify the terms of the OTC Collar 
Aggregation Exemption to apply to an entire conventional equity option 
position, not just the portion that is established pursuant to the 
Equity Option Hedge Exemption. NASD Regulation believes such an 
amendment is consistent with the economic logic underlying the OTC 
Collar Aggregation Exemption, i.e., that if the terms of the exemption 
are met, the segments of an OTC collar will never both be in-the-money 
at the same time or exercised. Under current rules, assuming that stock 
ABCD is subject to a basic position limit of 25,000 contracts, market 
participant taking advantage of the Equity Option Hedge Exemption could 
establish a hedged position on ABCD involving a total of 75,000 
conventional equity option contracts (three times the basic limit), 
including 50,000 contracts that are established under the Equity Option 
Hedge Exemption. A market participant using the OTC Collar Aggregation 
Exemption could then establish a conventional position of 50,000 long 
(short) calls and 50,000 short (long) puts, for a total of 125,000 
contracts overlying ABCD. The proposed rule change to the OTC Collar 
Aggregation Exemption would allow a market participant to establish a 
collar consisting of two segments, each of which involves a position 
three times greater than the basic position limit. Consequently, using 
the example above, a market participant could establish an OTC collar 
on ABCD involving 75,000 long (short) calls and 75,000 short (long) 
puts, for a total of 150,000 contracts.\11\
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    \11\ While the OTC Collar Aggregation Exemption is self-
effectuating with respect to the hedged components of conventional 
options positions, NASD Regulation has also permitted members to 
include non-hedged positions within OTC collars under the terms of 
the OTC Collar Aggregation Exemption on a pre-approval basis. 
Accordingly, the instant rule change would turn this pre-approval 
process for non-hedged components of OTC collars into a self-
effectuating process.
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    If, however, the basic position limits for conventional options 
were tripled, as proposed above, the permissible options position 
established under the OTC Collar Aggregation Exemption would be 
correspondingly increased. For example, if the market participant in 
the above example had increased the size of its conventional options 
position to 225,000 contracts pursuant to the Equity Option Hedge 
Exemption as proposed above (based upon a limit of three times the 
75,000 conventional equity options position limit), the market 
participant could establish an OTC collar on ABCD involving 225,000 
long (short) calls and 225,000 short (long) puts, for a total of 
450,000 contracts.
    Finally, in addition to the proposed rule changes discussed above, 
the NASD is proposing to clarify and update the examples contained in 
IM-2860-1 so that they are consistent with the instant proposal and 
prior increases in the hedge exemption.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\12\ 
which requires, among other things, that the Association's rules be 
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. NASD Regulation believes that the proposed rule change, which 
will increase the position limits on conventional equity options, 
disaggregate conventional equity options from exchange-traded equity 
options for position limit purposes, and provide that the OTC Collar 
Aggregation Exemption may be

[[Page 23321]]

utilized with respect to any conventional equity options position, not 
just that portion of the position that was established pursuant to the 
NASD's Equity Option Hedge Exemption, will enable market participants 
to establish larger positions in conventional equity options and, thus, 
will help to ensure that participants in the OTC options market are not 
placed at a competitive disadvantage vis-a-vis the exchange markets. In 
addition, NASD Regulation believes that increasing the position limits 
for conventional equity options will afford market participants, 
particularly portfolio managers, issuers, and sophisticated 
institutional investors, greater flexibility to employ larger options 
positions when effectuating their investment strategies.
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    \12\ 15 U.S.C. 78o-3(b).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Association does not believe that the proposed rule change will 
impose any inappropriate burden on competition.

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

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the publication of this notice in the Federal 
Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
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 at the 
Commission's Public Reference Room, located at the above address. 
Copies of such filing will also be available for inspection and copying 
at the principal office of the Exchange. All submissions should refer 
to File No. SR-NASD-98-23 and should be submitted by May 19, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-11169 Filed 4-27-98; 8:45 am]
BILLING CODE 8010-01-M