Document ID: SEC-2008-1323-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2008-09-30T04:00Z

[Federal Register: September 30, 2008 (Volume 73, Number 190)]
[Notices]               
[Page 56872-56876]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30se08-104]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58626; File No. SR-FINRA-2008-046]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change, and 
Amendment No. 1 Thereto, To Amend the By-Laws of FINRA Regulation To 
Realign the Representation of Industry Members on the National 
Adjudicatory Council To Follow More Closely the Categories of Industry 
Representation on the FINRA Board

September 23, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 8, 2008, Financial Industry Regulatory Authority, Inc. 
(``FINRA,'' f/k/a National Association of Securities Dealers, Inc. 
(``NASD'')) 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 substantially prepared by 
FINRA. On September 17, 2008, FINRA filed Amendment No. 1 to the 
proposed rule change. The Commission is publishing this notice to 
solicit comments on the proposed rule change, as amended, from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend the By-Laws of FINRA's regulatory 
subsidiary (``FINRA Regulation'') to realign the representation of 
industry members on the National Adjudicatory Council (``NAC'') to 
follow more closely the industry representation on the FINRA Board of 
Governors (``FINRA Board''), to eliminate the Regional Nominating 
Committees, to transfer such committees' responsibilities for NAC 
industry appointments to the FINRA Nominating Committee (``Nominating 
Committee''), and to change the name of ``NASD Regulation'' and 
``NASD'' to

[[Page 56873]]

``FINRA Regulation'' and ``FINRA'' respectively. The text of the 
proposed rule change is available at FINRA, on its Web site (http://
www.finra.org), and at the Commission's Public Reference Room.

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

    In its filing with the Commission, FINRA 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. FINRA 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
Background on FINRA and Its Regulatory Subsidiary
    On July 30, 2007, NASD and the New York Stock Exchange consolidated 
their member firm regulation operations into a combined organization, 
FINRA. As part of the consolidation, the SEC approved amendments to the 
NASD By-Laws to implement governance and related changes.\3\ The 
approved changes included a FINRA Board governance structure that 
balanced public and industry representation and designated seven 
governor seats to represent member firms of various sizes based on the 
criteria of firm size.
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    \3\ See Securities Exchange Act Release No. 56145 (July 26, 
2007), 72 FR 42169 (August 1, 2007), as amended by Securities 
Exchange Act Release No. 56145A (May 30, 2008), 73 FR 32377 (June 6, 
2008) (File No. SR-NASD-2007-023).
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    FINRA Regulation (formerly known as NASD Regulation) is a 
subsidiary of FINRA that operates according to the Plan of Allocation 
and Delegation of Functions by NASD to Subsidiaries, as amended, which 
NASD adopted first in 1996 when it formed NASD Regulation. FINRA 
Regulation's By-Laws were not amended at the time of the consolidation, 
other than in a few sections where those By-Laws conflicted with the 
new FINRA By-Laws.
    The proposed rule change would modify the FINRA Regulation By-Laws 
to: Restructure the industry representation on the NAC to parallel the 
firm-size criteria for industry representation on the FINRA Board; 
modify the nomination process for certain industry member seats on the 
NAC by using the Nominating Committee and discontinuing the Regional 
Nominating Committees; and adopt conforming changes to reflect the 
corporate name change and similar matters.\4\
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    \4\ The proposed rule change would revise, delete, and/or 
renumber various provisions of the FINRA Regulation By-Laws. 
Renumbered sections are referred to herein as ``proposed FINRA 
Regulation By-Laws.'' All other sections (that is, sections for 
which new numbering did not result from the proposed revisions) are 
referred to as ``current FINRA Regulation By-Laws.''
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The National Adjudicatory Council
    The NAC is appointed pursuant to the FINRA Regulation By-Laws to 
review all disciplinary decisions issued by Hearing Panels and presides 
over disciplinary matters that have been appealed to or called for 
review by the NAC. The NAC also reviews statutory disqualification 
matters and considers appeals of membership proceedings and exemption 
requests.\5\
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    \5\ See current FINRA Regulation By-Laws, Article V, Section 5.1 
(Appointment and Authority).
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    Under current FINRA Regulation By-Law provisions, the NAC must 
consist of no fewer than 12 and no more than 14 members.\6\ The number 
of non-industry members, including at least three public members, must 
equal or exceed the number of industry members.\7\ Since 1999, each of 
five geographic regions, which had been established by the NASD Board 
of Governors, has been represented on the NAC. Non-industry members of 
the NAC and two ``at-large'' industry members currently are nominated 
to serve on the NAC by the Nominating Committee and then appointed by 
the FINRA Regulation Board.\8\ The five industry members of the NAC who 
are drawn from the five geographic regions are first selected through 
Regional Nominating Committees (through either an uncontested or a 
contested nomination process), then nominated by the Nominating 
Committee, and finally appointed by the FINRA Regulation Board.
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    \6\ The 2008 NAC consists of 14 members, and the NAC has had no 
fewer than 14 members consistently for many years. To reflect past 
practices, the proposed rule change would eliminate the 12 to 14 
member range currently indicated in the FINRA Regulation By-Laws and 
state instead that the NAC shall consist of 14 members, divided 
equally between industry and non-industry. The proposal would 
eliminate the concept of non-industry members exceeding industry 
members and state simply that non-industry NAC members will equal 
industry NAC members. Given that the population of the NAC will be 
14, its balanced nature can be achieved with an equal industry/non-
industry composition.
    \7\ See current FINRA Regulation By-Laws, Article V, Section 5.2 
(Number of Members and Qualifications).
    \8\ Consistent with Article V of the FINRA Regulation By-Laws, 
the current 14-member NAC includes seven industry and seven non-
industry members. Five of the industry NAC members represent the 
five geographic regions. The remaining two industry seats are ``at-
large'' seats, which NASD historically used and FINRA currently uses 
to add balance to the types of firms being represented on the NAC.
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Discussion of Changes to the NAC Election Process

    The proposed rule change would amend Article I (Definitions), 
Article V (National Adjudicatory Council), and Article VI (National 
Adjudicatory Council Regional Nominations for Industry Members) of the 
FINRA Regulation By-Laws to replace the current regionally based 
approach for appointing industry representatives to the NAC with a 
process that is based on firm size and is similar to the FINRA Board's 
approach.\9\ The NAC's regionally based election process is a legacy 
NASD practice that no longer parallels the governance structure of the 
FINRA Board. The proposed rule change would replace the five regionally 
based industry members of the NAC with two small firm, one mid-size 
firm, and two large firm industry representatives. The make-up of the 
NAC under the proposed rule change would follow more closely the 
current make-up of the FINRA Board.
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    \9\ The FINRA Board consists of eleven Public Governors (who are 
appointed), ten Industry Governors (seven of whom are elected by 
industry members), the current Chief Executive Officer (``CEO'') of 
NYSE Regulation, and the current CEO of FINRA. The ten Industry 
Governors include: (a) Three elected Governors who are registered 
with member firms that employ 500 or more registered persons (Large 
Firm Governors); (b) one elected Governor who is registered with a 
member firm that employs at least 151 and no more than 499 
registered persons (Mid-Size Firm Governor); (c) three elected 
Governors who are registered with member firms that employ at least 
one and no more than 150 registered persons (Small Firm Governors); 
(d) one appointed Governor who is associated with a floor member of 
the New York Stock Exchange; (e) one appointed Governor who is 
associated with an independent contractor financial planning member 
firm or an insurance company affiliate; and (f) one appointed 
Governor who is associated with an affiliate of an investment 
company. See FINRA By-Laws, Article VII (Board of Governors).
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    The restructured NAC would therefore consist of 14 members, 
including seven industry members, two of whom are ``at large'' and five 
of whom are designated specifically as representatives of large firms, 
mid-size firms, and small firms, and seven non-industry members, three 
of whom are public.\10\ The tenure of NAC members is generally three 
years and the terms of the NAC members are staggered. The proposal 
would not disrupt the process

[[Page 56874]]

of approximately one-third of the NAC members completing their service 
in a particular year and being replaced with newly appointed NAC 
members. The proposal would result in a Small Firm and a Large Firm NAC 
Member joining the NAC near the beginning of 2009; a Mid-Sized Firm NAC 
Member joining in 2010; and a Small Firm and Large Firm NAC Member 
joining in 2011. The proposed selection process would allow for the 
service of NAC members with knowledge, impartiality, and judicial 
temperament, while maintaining the same level of indirect 
representation of FINRA's membership.
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    \10\ A public member of the NAC has no material business 
relationship with a broker or dealer or a self-regulatory 
organization registered under the Act.
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    In conjunction with eliminating the regionally based criteria for 
identifying industry NAC members, the proposed rule change also would 
simplify the NAC appointment process for industry representatives and 
follow more closely the procedures for electing industry members of the 
FINRA Board. The process proposed would eliminate the five Regional 
Nominating Committees and have the Nominating Committee perform their 
functions instead. Rather than relying on Regional Nominating 
Committees to first identify possible industry candidates before 
submission of the candidates to the Nominating Committee and the FINRA 
Regulation Board, the Nominating Committee would identify and solicit 
candidates for all NAC seats, including the five industry-member 
positions that are based on firm size.\11\ The Nominating Committee 
would be free to consult with or receive recommendations for industry 
NAC members from other FINRA committees, such as the District 
Nominating Committees, before communicating its nominations to the 
FINRA Board.
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    \11\ See proposed FINRA Regulation By-Laws, Article V, Section 
5.3 (Appointments).
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    The proposed rule change would continue the current process of 
allowing individuals who seek to serve on the NAC but were not 
nominated, known as additional candidates, to gather petitions in 
support of their candidacy and potentially compete in a contested 
election. Additional candidates would petition to be considered as 
Small, Mid-Size, or Large Firm NAC Members based on the size of the 
firm with which they are registered.
    Under the proposal, additional candidates would be able to qualify 
for a contested election by gathering petitions from three percent of 
the firms in their size category, which is lower than the ten percent 
requirement additional candidates currently need to gather when they 
seek to qualify for a regional NAC seat.\12\ In the event of a 
contested election, FINRA members would have an opportunity to vote for 
a NAC candidate based on firm size.\13\ Specifically, small, mid-size, 
or large firms would vote for NAC candidates only if the contested 
election was for a NAC seat designated for a firm of corresponding 
size.
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    \12\ Compare current FINRA Regulation By-Laws, Article VI, 
Section 6.15 (Requirement for Petition Supporting Additional 
Candidate) with proposed FINRA Regulation By-Laws, Article VI, 
Section 6.2 (Designation of Additional Candidates).
    \13\ See proposed FINRA Regulation By-Laws, Article VI, Section 
6.3 (List of FINRA Members Eligible to Vote) and Article VI, Section 
6.7 (Ballots).
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    The proposed rule change would ensure that the winner of a 
contested election serves on the NAC. While all NAC members would 
continue to be recommended initially by the Nominating Committee and 
appointed by the FINRA Board,\14\ the candidate who receives the most 
votes in any contested election for a Small, Mid-Size, or Large Firm 
NAC Member seat would be required under the FINRA Regulation By-Laws to 
be appointed to the NAC.\15\ The current By-Law section that discusses 
the procedure in the event that the Regional Nominating Committee's 
nominee is rejected by the National Nominating Committee would 
accordingly be deleted. The proposal would not change the NAC selection 
process if no additional candidates reach the threshold to qualify for 
a contested election. As in the past when there are no additional 
candidates, the industry NAC members selected by the Nominating 
Committee would not have a contested election and would be recommended 
for appointment to the NAC.\16\
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    \14\ The seven non-industry members and two at-large industry 
members would continue to follow the nomination and Board 
appointment process currently employed for non-industry and at-large 
industry NAC members.
    \15\ See proposed FINRA Regulation By-Laws, Article V, Section 
5.3 (Appointments) and 5.5 (Rejection of Nominating Committee 
Nominee).
    \16\ The proposed FINRA Regulation By-Laws retain the 
possibility that the Nominating Committee could propose two or more 
candidates for a single open small, mid-size, or large firm NAC 
seat. See proposed FINRA Regulation By-Laws, Article VI, Section 6.5 
(Notice of Contested Nomination). In such a case, there would be a 
contested election. The proposed rule change would clarify that only 
when the Nominating Committee nominates two or more candidates for 
the same open seat would the Nominating Committee trigger a 
contested election.
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    To verify that a NAC nominee or candidate would satisfy the 
definition of an Industry, Small Firm, Mid-Sized Firm, Large Firm, Non-
Industry, or Public Member of the NAC, the proposed rule change would 
authorize the FINRA Secretary to collect information from candidates as 
is reasonably necessary to serve as the basis for such a 
determination.\17\
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    \17\ See proposed FINRA Regulation By-Laws, Article V, Section 
5.4 (Nomination Process).
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    The proposed rule change would modify slightly the provision that 
restricts NAC members and certain committees from communicating in an 
official capacity in support of a candidate in a contested election. 
The current rules, which permit individuals who are Directors or NAC or 
other committee members to communicate their views regarding a 
candidate in an individual capacity, would remain the same. The 
modification would specify the narrow circumstances under which the 
Nominating Committee may support its candidate by sending a maximum of 
two mailings in support of its nominee.\18\ The proposal would clarify 
that this limited support is available during contested NAC elections 
by referring to support allowed ``under these By-Laws,'' which includes 
the support allowed under Article IV, Section 4.16.\19\
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    \18\ See proposed FINRA Regulation By-Laws, Article IV, Section 
4.16(b) (Communication of Views Regarding Contested Election or 
Nomination). Section 4.16(b) would also mirror the language of the 
FINRA By-Law provision that allows, in contested elections, the 
appropriate FINRA committee to communicate a responsive message in 
reply to an additional candidate's communication. See FINRA By-Laws, 
Article VII, Section 11(b) (Communication of Views).
    \19\ See proposed FINRA Regulation By-Laws, Article VI, Section 
6.6 (Administrative Support).
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    The proposed rule change would designate the Secretary of FINRA, 
instead of the FINRA Regulation Secretary, as the person who would send 
notice to FINRA members announcing a contested NAC election; assist in 
preparing ballots; prepare a list of FINRA members eligible to vote; 
arrange for the location for counting of ballots by an independent 
agent; resolve ballots that were set aside, if necessary; extend a time 
period regarding elections for good cause; and similar duties.\20\ The 
proposal designates the FINRA Secretary because this office fulfills 
the same role when FINRA holds elections for the Board of Governors.
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    \20\ See proposed FINRA Regulation By-Laws, Article VI, Sections 
6.5, 6.7, 6.8, 6.10, 6.11, 6.13, and 6.14.
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    As a result of the NAC's restructuring, FINRA would continue to 
promote fair representation of its members because seven of the NAC 
seats will be drawn from members of the industry and the industry 
candidates for five of those seats will be announced to the membership 
and are subject to a potential election by member firms of a similar 
size.

[[Page 56875]]

    In addition, the rule change would indicate in proposed Article V, 
Section 5.10 (Filling of Vacancies) that the NAC may continue to 
function while FINRA fills a vacancy on the NAC. The proposal also 
would incorporate the concept into Section 5.10 from proposed Section 
5.9 (Disqualification), which specifies that a vacancy on the NAC 
lasting six months or less will not cause a violation of the 
compositional requirements of current Article V, Section 5.2 (Number of 
Members and Qualifications).
    The proposed rule change would amend the FINRA Regulation By-Law 
provisions regarding resignation, removal, appointment, and 
disqualification of NAC members and the NAC's authority to act on 
FINRA's behalf by designating the FINRA Board as the body authorized to 
oversee the NAC.\21\ The FINRA Board has long had explicit authority 
under Articles XII and XIII of its By-Laws to establish procedures for 
disciplinary proceedings and to impose sanctions in certain 
circumstances, and has consistently relied on the NAC to render 
judgment on disciplinary matters, including imposing sanctions. The 
proposal would reinforce these roles by simplifying the FINRA Board's 
relationship with the NAC and establishing directly with the FINRA 
Board the authority to remove all NAC members (for refusal, failure, 
neglect, or inability to discharge duties), accept their resignations, 
appoint them, and declare them disqualified. Moreover, the FINRA 
Board's direct authority over resignation, removal, appointment, and 
disqualification would logically extend the FINRA Board's existing 
authority to review the substance of the NAC's appellate decisions, 
which exists through the FINRA Board's discretionary power to call a 
case for review by the FINRA Board.\22\ FINRA believes that the 
proposed rule change will benefit the appellate portion of the 
disciplinary process by extending the FINRA Board's oversight of the 
NAC's members.
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    \21\ See current FINRA Regulation By-Laws, Article V, Sections 
5.1 (Appointment and Authority), and proposed Sections 5.7-5.9.
    \22\ See Rule 9351.
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    The proposed rule change would amend current Article V, Section 5.2 
of the FINRA Regulation By-Laws (Number of Members and Qualifications) 
to eliminate the reference that the Chair of the NAC shall 
automatically serve as a Director of the FINRA Regulation Board for a 
one-year term. As a result of the NASD and NYSE consolidation, the NAC 
Chair's automatic service on the FINRA Board of Governors was 
previously eliminated in 2007. Accordingly, the NAC Chair no longer 
automatically has the prerequisite requirement to be appointed to the 
FINRA Regulation Board.\23\
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    \23\ Additional changes to the FINRA Regulation By-Laws 
regarding the FINRA Regulation Board and capital stock will be 
proposed by FINRA in a related proposed rule change that FINRA 
anticipates filing in the near future.
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Conforming Changes Relating to the New FINRA Name
    The proposed rule change would make certain non-substantive changes 
to several articles of the FINRA Regulation By-Laws as follows:
     ``The NASD'' or ``NASD'' is replaced with ``FINRA'' or 
``the Corporation'';
     ``NASD Regulation'' is changed to ``FINRA Regulation'';
     ``the Rules of the Association'' is replaced with ``the 
Rules of the Corporation;'' and
     ``National Nominating Committee'' is replaced with 
``Nominating Committee.''
    The proposed rule change would modify the term ``Industry Member'' 
in the definitional section of FINRA Regulation's By-Laws, Article I, 
by limiting the look-back test that characterizes NAC or committee 
members as industry if they have served as an officer, director, or 
employee of a broker or dealer, among other reasons, within the past 
twelve months. The current provision uses a three year look-back test. 
This proposed change would make the definition of ``Industry Member'' 
for NAC and other committee members consistent with the ``Industry 
Governor'' and ``Industry committee member'' definitions in the FINRA 
By-Laws.\24\
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    \24\ See FINRA By-Laws, Article I(t).
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    The proposal would also add the term ``independent director'' to 
the portion of the definition of ``Industry Member'' that excludes 
outside directors of a broker or dealer. Independent director is 
synonymous with outside director, but would be added to the 
exclusionary clause to harmonize the FINRA Regulation By-Laws with the 
FINRA By-Laws' use of the term ``independent director'' when defining 
an Industry Governor. In addition, the definition of ``Public 
Director'' and ``Public Member,'' which refers to NAC or committee 
members, would be modified to clarify that, for example, a Public 
Director's service on FINRA Regulation's Board or a Public Member's 
service on the NAC does not disqualify that person from satisfying the 
definition of Pubic Director or Public Member.\25\
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    \25\ See proposed FINRA Regulation By-Laws, Article I(hh) and 
(ii).
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    The proposed rule change would reflect that FINRA Regulation's 
Delaware registered agent is Corporate Creations Network Inc.
    The effective date of the proposed rule change will be the date of 
Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\26\ which requires, among 
other things, that FINRA rules must be 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 Section 15A(b)(4) of the Act,\27\ which requires 
that FINRA rules are designed to assure a fair representation of 
FINRA's members in the administration of its affairs. The composition 
of the FINRA Board has previously been found to meet the statutory 
requirement, and FINRA believes that the proposed rule change will 
align the representation of industry members on the NAC to follow more 
closely the industry representation on the FINRA Board.
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    \26\ 15 U.S.C. 78o-3(b)(6).
    \27\ 15 U.S.C. 78o-3(b)(4).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

    Written comments were neither solicited nor received.

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

    Within 35 days of the date of 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 reason for so finding or (ii) as to 
which FINRA consents, the Commission will:
    A. By order approve such proposed rule change; or

[[Page 56876]]

    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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2008-046 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2008-046. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-FINRA-2008-046 and should be 
submitted on or before October 21, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-22927 Filed 9-29-08; 8:45 am]

BILLING CODE 8010-01-P