Document ID: SEC-2009-1525-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule Change Relating to FINRA's Rules Governing Clearly Erroneous Executions
Posted Date: 2009-10-28T04:00Z

[Federal Register: October 28, 2009 (Volume 74, Number 207)]
[Notices]               
[Page 55606-55610]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28oc09-128]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60851; File No. SR-FINRA-2009-068]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change Relating to 
FINRA's Rules Governing Clearly Erroneous Executions

October 21, 2009.
    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 October 19, 2009, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc. 
(``NASD'')) filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by FINRA. 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).
    \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 adopt NASD Rule 11890, IM-11890-1, and IM-
11890-2 into the Consolidated FINRA Rulebook as part of a new FINRA 
Rule 11890 Series governing clearly erroneous transactions and to amend 
these rules as part of a market-wide effort designed to provide 
transparency and finality with respect to clearly erroneous executions.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

[[Page 55607]]

 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
    As part of the process of developing a new consolidated rulebook 
(``Consolidated FINRA Rulebook''),\3\ FINRA is proposing that NASD Rule 
11890, IM-11890-1, and IM-11890-2 be moved into the Consolidated FINRA 
Rulebook as part of a new FINRA Rule 11890 Series governing clearly 
erroneous transactions.\4\ FINRA is also proposing to amend these rules 
as part of a market-wide effort designed to provide transparency and 
finality with respect to clearly erroneous executions.\5\ This effort 
seeks to achieve consistent results for participants across U.S. 
equities exchanges while maintaining a fair and orderly market, 
protecting investors, and protecting the public interest. Unlike the 
rules of the U.S. equities exchanges, FINRA's rules also address 
clearly erroneous executions in OTC Equity Securities.\6\ NASD Rule 
11890 currently provides that, in the event of a disruption or 
malfunction related to the use or operation of any quotation, 
communication, or trade reporting system owned or operated by FINRA, or 
under extraordinary market conditions, designated officers of FINRA can 
review an over-the-counter (``OTC'') transaction arising out of or 
reported through any such quotation, communication, or trade reporting 
system, and may declare the transaction null and void or modify the 
terms if any such officer determines that the transaction is clearly 
erroneous or that such action is necessary for the maintenance of a 
fair and orderly market or the protection of investors and the public 
interest. IM-11890-1 and IM-11890-2 address rulings made by FINRA and 
the UPC Committee pursuant to NASD Rule 11890 and the review of those 
rulings.
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    \3\ The current FINRA rulebook consists of (1) FINRA Rules; (2) 
NASD Rules; and (3) rules incorporated from NYSE (``Incorporated 
NYSE Rules'') (together, the NASD Rules and Incorporated NYSE Rules 
are referred to as the ``Transitional Rulebook''). While the NASD 
Rules generally apply to all FINRA members, the Incorporated NYSE 
Rules apply only to those members of FINRA that are also members of 
the NYSE (``Dual Members''). The FINRA Rules apply to all FINRA 
members, unless such rules have a more limited application by their 
terms. For more information about the rulebook consolidation 
process, see Information Notice, March 12, 2008 (Rulebook 
Consolidation Process).
    \4\ FINRA will transfer the remaining rules in the Uniform 
Practice Code into the Consolidated FINRA Rulebook in a separate 
filing.
    \5\ See Securities Exchange Act Release No. 60706 (September 22, 
2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSEArca-2009-
36).
    \6\ For purposes of the proposed rule change, the term ``OTC 
Equity Security'' has the same meaning as defined in FINRA Rule 
6420, except that the term does not include any equity security that 
is traded on any national securities exchange.
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    NASD Rule 11890 provides important safeguards against market 
disruptions caused by trader errors, system malfunctions, or other 
extraordinary events that result in erroneous executions affecting 
multiple market participants and/or securities. NASD Rule 11890 has 
been used both with respect to events affecting a single stock, such as 
an extraordinary erroneous order causing a large number of trades 
involving multiple market participants in a single stock (single stock 
events), and events affecting multiple stocks, such as a system 
malfunction resulting in a more widespread problem (multi-stock 
events).
    In addition to the substantive changes to the clearly erroneous 
provisions described below, the proposed rule change structurally 
alters the provisions as well. FINRA is proposing to create a new 
clearly erroneous series of rules: FINRA Rule Series 11890. Under this 
umbrella would be (1) a general provision (Rule 11891) with 
accompanying Supplementary Material; (2) a rule governing clearly 
erroneous determinations for transactions in exchange-listed securities 
(Rule 11892) with accompanying Supplementary Material; (3) a rule 
governing clearly erroneous determinations for transactions in OTC 
Equity Securities (Rule 11893) with accompanying Supplementary 
Material; and (4) a rule governing review of FINRA staff determinations 
by the UPC Committee (Rule 11894).
Definition and General Guidelines
    The proposed rule change creates Rule 11891, which defines the term 
``clearly erroneous'' for purposes of the new FINRA Rule 11890 Series. 
The proposed rule specifies that ``the terms of a transaction are 
`clearly erroneous' when there is an obvious error in any term, such as 
price, number of shares, or other unit of trading, or identification of 
the security.'' The language in the rule is based on the definition in 
the recently approved amendments to NYSE Arca Rule 7.10.\7\
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    \7\ See Securities Exchange Act Release No. 60706 (September 22, 
2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSEArca-2009-
36).
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    The proposed rule change also includes four proposed paragraphs of 
Supplementary Material to Rule 11891. Proposed Supplementary Material 
.01 renumbers current NASD IM-11890-1 regarding a member's failure to 
abide by FINRA or UPC Committee rulings. Proposed Supplementary 
Material .02 and .03 set forth the general standards applicable to 
clearly erroneous determinations and clarify that FINRA generally 
considers a transaction to be clearly erroneous when there is a 
systemic problem that involves large numbers of parties or trades, or 
conditions where it would be in the best interests of the market. 
Further, extraordinary market conditions may include situations where 
an extraordinary event has occurred or is ongoing that has had a 
material effect on the market for a security traded over-the-counter or 
has caused major disruption to the marketplace. Supplementary Material 
.02 also emphasizes that members are responsible for ensuring that the 
appropriate price and type of order are entered into FINRA systems.
    Finally, proposed Supplementary Material .04 specifically addresses 
suspicious trading activities such as unauthorized trading activity or 
attempts to manipulate stock prices by illegally gaining access to 
legitimate accounts or opening new accounts using false information 
(often referred to as ``account intrusion''). Although FINRA continues 
to be concerned about protecting markets from unauthorized or illegal 
activity like account intrusion that could disrupt a fair and orderly 
market, FINRA believes that its clearly erroneous authority does not 
extend to such suspicious trading activities. Rather, FINRA believes 
such activities relate to allegations of fraud and fall outside the 
scope of the clearly erroneous rules.\8\ Consequently, FINRA is 
proposing the Supplementary Material to clarify this position while

[[Page 55608]]

also noting that members should routinely review the adequacy of their 
internal controls and ensure that appropriate system safeguards are in 
place to minimize or eliminate the potential for account intrusion.
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    \8\ In approving recent amendments to Nasdaq's clearly erroneous 
rule, the Commission noted that, ``[g]iven the fact that the Clearly 
Erroneous Rule is designed to address trades made in error and the 
more difficult factual analysis presented by expanding the rule's 
application beyond obvious errors,'' it was appropriate for Nasdaq 
to ``retain the original scope of the [clearly erroneous] rule'' 
rather than extend the rule to address account intrusion. See 
Securities Exchange Act Release No. 57826 (May 15, 2008), 73 FR 
29802 (May 22, 2008).
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Review of Transactions in Exchange-Listed Securities
    Proposed Rule 11892 and its Supplementary Material set forth the 
standards FINRA uses to determine whether a transaction in an exchange-
listed security is clearly erroneous. FINRA believes that coordinating 
with other self-regulatory organizations with the goal of having 
consistency and transparency regarding the clearly erroneous process is 
important to the marketplace and to investors. Consequently, for OTC 
transactions in exchange-listed securities that are reported to a FINRA 
system, such as a FINRA Trade Reporting Facility (``TRF'') or 
Alternative Display Facility (``ADF''), FINRA will generally follow the 
determination of a national securities exchange to break a trade (or 
multiple trades) when that national securities exchange has broken one 
or more trades at or near the price range in question at or near the 
time in question (in FINRA staff's sole discretion) such that FINRA 
breaking such trade(s) would be consistent with market integrity and 
investor protection. When multiple national securities exchanges have 
related trades, FINRA will leave a trade(s) unbroken when any of those 
national securities exchanges has left a trade(s) unbroken at or near 
the price range in question at or near the time in question (in FINRA 
staff's sole discretion) such that FINRA breaking such trade(s) would 
be inconsistent with market integrity and investor protection.\9\
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    \9\ See proposed Rule 11892, Supplementary Material .01.
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    With respect to OTC transactions in exchange-listed securities for 
which there is no corresponding or related on-exchange trading 
activity, FINRA believes that the best approach in determining whether 
to declare transactions clearly erroneous is to follow the exchanges' 
criteria when making a clearly erroneous determination. In this sector 
of the market, FINRA believes that consistency in application of 
clearly erroneous authority across markets is critical to ensure that 
one investor does not receive disparate treatment based solely on the 
ultimate execution or reporting venue of his or her order. 
Consequently, for OTC transactions in exchange-listed securities that 
are reported to a FINRA system, such as a FINRA TRF or the ADF, but for 
which there is no corresponding or related on-exchange trading 
activity, FINRA will generally make its own clearly erroneous 
determination.\10\ However, to ensure that transactions in exchange-
listed securities are treated consistently regardless of where the 
trade is executed (i.e., on an exchange or OTC), proposed Rule 11892 
replicates the numerical thresholds used by the exchanges to determine 
whether a transaction is eligible for consideration as clearly 
erroneous. The proposed rule also establishes provisions for the use of 
alternative reference prices in unusual circumstances, additional 
factors that FINRA may consider when making a clearly erroneous 
determination, and numerical guidelines applicable to volatile market 
opens. Each of these provisions is modeled on similar provisions in the 
recently approved amendments to NYSE Arca Rule 7.10.\11\
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    \10\ Unlike the NYSE Arca rule regarding clearly erroneous 
determinations, the FINRA rules do not allow members to initiate 
reviews of transactions. All reviews conducted by FINRA are 
conducted on FINRA's own motion.
    \11\ See Securities Exchange Act Release No. 60706 (September 
22, 2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSEArca-
2009-36).
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Review of Transactions in OTC Equity Securities
    Currently, NASD Rule 11890 governs FINRA's clearly erroneous 
process for both exchange-listed securities and OTC Equity Securities. 
The core purpose of the clearly erroneous rules is to grant FINRA 
authority to determine that a transaction is clearly erroneous with a 
goal of maintaining market integrity by declaring a transaction (or 
multiple transactions, if necessary) to be null and void if the terms 
of the trade are clearly out of line with objective market conditions 
for the security.\12\ FINRA is proposing to apply its clearly erroneous 
authority somewhat differently depending on whether the security is 
listed on a national securities exchange or is an OTC Equity Security. 
For that reason, FINRA is proposing to create separate rules for the 
treatment of exchange-listed securities, which would be governed by 
Rule 11892, and OTC Equity Securities, which would be governed by Rule 
11893.
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    \12\ NASD Rule 11890 currently gives FINRA officers the 
authority to modify the terms of a transaction, in addition to 
declaring the transaction null and void. To conform FINRA's 
authority to the other exchanges' in the context of clearly 
erroneous determinations, FINRA is proposing to eliminate its 
ability to modify a clearly erroneous execution. See id.
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    Proposed Rule 11893 is structured similarly to the provisions for 
transactions in exchange-listed securities under proposed Rule 11892, 
including numerical guidelines, the use of alternative reference prices 
in unusual circumstances, and additional factors FINRA officers may 
consider when making a clearly erroneous determination. However, as is 
the case today, the proposed numerical guidelines for transactions in 
OTC Equity Securities are not the same as the guidelines used for 
exchange-listed securities. The proposed rule change would codify the 
numerical guidelines currently used by FINRA to determine whether a 
transaction is eligible for clearly erroneous consideration. In some 
instances, for example, the percentage deviations set forth in the 
numerical guidelines are based on a sliding scale where the maximum 
percentage deviation applies to the lower execution price in the range 
and the minimum percentage deviation applies to the higher execution 
price in the range. The sliding scale is applied in a generally linear 
fashion (i.e., prices at the lower end of the reference price range are 
generally assessed at the higher percentage range) and is intended to 
smooth the percentage changes from tier to tier and allow for more 
gradual deviations. Because the sliding scale is not applied on a 
strictly linear basis, FINRA has more discretion in applying the 
guidelines for executions within the reference price range rather than 
being strictly a calculation of percentages.
    The following chart summarizes the proposed Numerical Guidelines 
for clearly erroneous determinations for OTC Equity Securities:

------------------------------------------------------------------------
                                          Numerical guidelines (Subject
                                             transaction's percentage
            Reference price               difference from the reference
                                                      price)
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$0.9999 and under......................  20%.
$1.0000 and up to and including $4.9999  Low end of range minimum 20%--
                                          High end of range minimum 10%.
$5.0000 and up to and including          10%.
 $74.9999.
$75.0000 and up to and including         Low end of range minimum 10%--
 $199.9999.                               High end of range minimum 5%.

[[Page 55609]]

$200.0000 and up to and including        5%.
 $499.9999.
$500.0000 and up to and including        Low end of range minimum 5%--
 $999.9999.                               High end of range minimum 3%.
$1,000.0000 and over...................  3%.
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    For example, a transaction executed at $1.5000 that deviates by 
more than $0.30 (or 20%) from the prevailing market price may be 
eligible for cancellation as ``clearly erroneous''; whereas a 
transaction executed at $4.5000 that deviates by more than $0.45 (or 
10%) from the prevailing market price may be eligible for cancellation 
as ``clearly erroneous.'' The provisions in proposed Rule 11893 
regarding alternative reference prices and additional factors are 
substantially similar to those set forth in Rule 11892 for exchange-
listed securities.
    FINRA is also proposing to adopt Supplementary Material to Rule 
11893 to emphasize that FINRA has historically exercised its clearly 
erroneous authority in very limited circumstances, in particular with 
respect to OTC Equity Securities. This more narrow approach for OTC 
Equity Securities is due to the differences in the OTC equity and 
exchange-listed markets, including the lack of compulsory information 
flows in the OTC equity market that come as a result of the listing 
process and the fact that aberrant trading in the OTC market is often 
due to issues other than systems problems or extraordinary events. The 
Supplementary Material explains that FINRA does not expect to use its 
clearly erroneous authority in most situations; rather, FINRA expects 
the parties to settle any dispute privately.
Review Procedures
Initial Determinations
    As noted above, FINRA is proposing to remove language that 
currently allows a FINRA officer to modify one or more of the terms of 
a transaction under review. Under the proposed rules, the FINRA officer 
will only have the authority to break the trades. This proposed change 
is intended to conform with the rules of other exchanges and attempts 
to remove the subjectivity from the rule that is necessitated by an 
adjustment. The proposed rule governing initial determinations remains 
substantially similar to that in current NASD Rule 11890. An Executive 
Vice President of FINRA's Market Regulation Department or Transparency 
Services Department, or any officer designated by such Executive Vice 
President, may, on his or her own motion, review any transaction 
arising out of or reported through any FINRA facility. With respect to 
determinations involving transactions in exchange-listed securities, 
absent extraordinary circumstances, the officer shall take action 
generally within 30 minutes after becoming aware of the transaction. 
When extraordinary circumstances exist, any such action of the officer 
must be taken no later than the start of trading on the day following 
the date of execution(s) under review. With respect to determinations 
involving transactions in OTC Equity Securities, a FINRA officer must 
make a determination as soon as possible after becoming aware of the 
transaction, but in all cases by 3:00 p.m., Eastern Time, on the next 
trading day following the date of the transaction at issue. If a FINRA 
officer declares any transaction null and void, FINRA will notify each 
party involved in the transaction as soon as practicable, and any party 
aggrieved by the action may appeal such action in accordance with Rule 
11894, unless the officer making the determination also determines that 
the number of the affected transactions is such that immediate finality 
is necessary to maintain a fair and orderly market and to protect 
investors and the public interest.
Appeals
    FINRA is proposing to codify in a separate rule (Rule 11894) the 
provisions governing the appeal to the UPC Committee of a FINRA 
officer's determination to declare an execution clearly erroneous.\13\ 
IM-11890-2, which concerns review by panels of the UPC Committee, will 
be incorporated into the text of the new rule. Under the rule, an 
appeal must be made in writing and must be received by FINRA within 
thirty minutes after the person making the appeal is given the 
notification of the determination being appealed. With respect to 
appeals regarding exchange-listed securities, determinations by the UPC 
Committee will be rendered as soon as practicable, but generally, on 
the same trading day as the execution(s) under review. On requests for 
appeal received after 3:00 p.m., Eastern Time, a determination will be 
rendered as soon as practicable, but in no case later than the trading 
day following the date of the execution(s) under review. With respect 
to appeals regarding OTC Equity Securities, determinations by the UPC 
Committee will be rendered as soon as practicable, but in no case later 
than two trading days following the date of the execution(s) under 
review.
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    \13\ As the rule makes clear, a FINRA officer's determination 
not to break a trade is not appealable.
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    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be 30 days following 
publication of the Regulatory Notice announcing 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,\14\ 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. FINRA believes that adopting guidelines to explain the 
application of the clearly erroneous process will provide clarity and 
consistency to the marketplace. In addition, FINRA believes if 
consistent standards are applied to this process across markets, then 
greater efficiency can be reached.
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    \14\ 15 U.S.C. 78o-3(b)(6).
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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

[[Page 55610]]

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 such 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. 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-2009-068 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2009-068. 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, 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 the Exchange. 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-2009-068 and should be submitted on or before 
November 18, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-25873 Filed 10-27-09; 8:45 am]

BILLING CODE 8011-01-P