Document ID: SEC-2009-1210-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule Change To Extend Certain Regulation NMS Protections to Quoting and Trading in the Market for OTC Equity Securities
Posted Date: 2009-08-26T04:00Z

[Federal Register: August 26, 2009 (Volume 74, Number 164)]
[Notices]               
[Page 43207-43210]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr26au09-135]                         

[[Page 43207]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60515; File No. SR-FINRA-2009-054]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change To Extend 
Certain Regulation NMS Protections to Quoting and Trading in the Market 
for OTC Equity Securities

August 17, 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 August 7, 2009, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') 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 new FINRA Rules 6434 (Minimum Pricing 
Increment for OTC Equity Securities), 6437 (Prohibition from Locking or 
Crossing Quotations in OTC Equity Securities), 6450 (Restrictions on 
Access Fees) and 6460 (Display of Customer Limit Orders).
    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.

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
    FINRA is proposing to adopt new rules to extend certain Regulation 
NMS protections to quoting and trading in over-the-counter equity 
securities (``OTC Equity Securities'').\3\ Specifically, FINRA is 
proposing rules to: (1) Restrict sub-penny quoting; (2) restrict locked 
and crossed markets; (3) implement a cap on access fees; and (4) 
require the display of customer limit orders.\4\
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    \3\ ``OTC Equity Security'' means any non-exchange-listed 
security and certain exchange-listed securities that do not 
otherwise qualify for real-time trade reporting. See FINRA Rule 
6420(d).
    \4\ The proposed rule also corrects certain cross-references to 
FINRA rules that have been adopted in the consolidated FINRA 
rulebook.
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A. Background

    On June 9, 2005, the SEC adopted Regulation NMS.\5\ Regulation NMS, 
in addition to re-designating the national market system rules 
previously adopted under Section 11A of the Act, also established new 
substantive rules to modernize and strengthen the regulatory structure 
of the U.S. equity markets.
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    \5\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496 (June 29, 2005) (``Regulation NMS Adopting 
Release'').
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    Among other things, in adopting Regulation NMS, the SEC prohibited 
the imposition of access fees in excess of certain prescribed 
limitations; required SRO rules to address locked or crossed 
quotations; and prohibited the display of orders, quotations, and 
indications of interest in a pricing increment smaller than a penny 
(except where the security is priced at less than $1.00 per share in 
which case certain restrictions apply). Regulation NMS also includes a 
pre-existing customer limit order display requirement, which renumbered 
Exchange Act Rule 11Ac1-4 as Rule 604 under the Regulation.
    These provisions of Regulation NMS apply only to trading in NMS 
stocks as defined in Rule 600(b)(47) of Regulation NMS and do not apply 
to trading in OTC Equity Securities. FINRA previously filed with the 
SEC rule changes to apply aspects of Regulation NMS to quoting and 
trading in OTC Equity Securities. In particular, FINRA filed with the 
SEC a proposed rule change to impose sub-penny quoting prohibitions on 
OTC Equity Securities and a separate proposed rule change to impose 
restrictions on access fees.\6\
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    \6\ See Securities Exchange Act Release No. 52280 (August 17, 
2005), 70 FR 49959 (August 25, 2005) (Proposed rule change to impose 
restrictions on the display of quotes and orders in sub-penny 
increments for non-Nasdaq OTC equity securities; File No. SR-NASD-
2005-095). See Securities Exchange Act Release No. 55717 (May 7, 
2007), 72 FR 26856 (May 11, 2007) (Proposed amendment to exclude 
from the access fee display requirements any access fees below a 
specified level; File No. SR-NASD-2007-029).
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    In light of developments to date, FINRA has determined that 
extending certain NMS principles to the OTC equity market would be best 
if proposed together, rather than individually. Thus FINRA is now 
proposing to adopt rules to: (1) Restrict sub-penny quoting; (2) 
restrict locked and crossed markets; (3) implement a cap on access 
fees; and (4) require the display of customer limit orders. FINRA 
believes that these Regulation NMS principles, if applied to OTC Equity 
Securities, would enhance market quality and investor protections in 
this market.

B. Restrictions on Sub-penny Quoting

    FINRA is proposing new FINRA Rule 6434 (Minimum Pricing Increment 
for OTC Equity Securities) to impose restrictions on the display of 
quotes and orders in sub-penny increments for OTC Equity Securities. 
Specifically, FINRA is proposing to prohibit members from displaying, 
ranking, or accepting from any person a bid or offer, order, or 
indication of interest in an OTC Equity Security in an increment 
smaller than $0.01 if the bid or offer, order, or indication of 
interest is priced $1.00 or greater per share, in an increment smaller 
than $0.0001 if the bid or offer, order, or indication of interest is 
priced below $1.00 and greater than $0.01 per share, and in an 
increment smaller than $0.000001 if the bid or offer, order or 
indication of interest is priced less than $0.01 per share.
    Market participants currently quote in increments ranging from 
pennies to hundredths of pennies. As the SEC stated in the proposing 
release for Regulation NMS and in the Regulation NMS Adopting Release, 
potential harms associated with sub-penny quoting include an increase 
in the incidence of market participants stepping ahead of standing 
limit orders for an economically insignificant amount and added 
difficulty for broker-dealers to meet certain of their regulatory 
obligations by increasing the incidence of so-called ``flickering'' 
quotes.\7\ FINRA believes that essentially the same potential problems 
exist with respect to sub-penny quoting in OTC Equity Securities. 
Accordingly, FINRA is

[[Page 43208]]

proposing a new rule that would adopt an approach to sub-penny quoting 
that is consistent with that implemented by the SEC in Regulation NMS.
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    \7\ See Securities Exchange Act Release No. 49325 (Feb. 26, 
2004), 69 FR 11126 (Mar. 9, 2004). See also Securities Exchange Act 
Release No. 50870 (December 16, 2004), 69 FR 77423 (December 27, 
2004).
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    FINRA believes that the proposed restrictions on sub-penny quoting 
will promote greater price transparency and consistency. As noted 
above, FINRA also believes that sub-penny restrictions limit the 
practice of ``stepping ahead'' of displayed limit orders by trivial 
amounts and, therefore, the proposed new rule should further encourage 
the display of limit orders and improve the depth and liquidity of the 
market.

C. Locked and Crossed Markets

    FINRA rules do not currently prohibit locking or crossing 
quotations in OTC Equity Securities.\8\ As the SEC noted in the 
Regulation NMS Adopting Release, locked and crossed markets can cause 
confusion among investors concerning trading interest in a stock and, 
therefore, FINRA believes that restricting the practice of submitting 
locking or crossing quotations will enhance the usefulness of quotation 
information for OTC Equity Securities.
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    \8\ A ``locking quotation'' is the display of a bid (or offer) 
at a price that equals the displayed price of an offer (or bid) for 
a security in the same ``inter-dealer quotation system'' (as defined 
in proposed Rule 6437). A ``crossing quotation'' is the display of a 
bid (or offer) at a price that is higher than the displayed price of 
an offer (or bid) for a security in the same inter-dealer quotation 
system.
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    Rule 610(d) of Regulation NMS (Access to Quotations) requires that 
each national securities exchange and national securities association 
establish, maintain, and enforce written rules restricting locking and 
crossing activities. In furtherance of this requirement, FINRA adopted 
Rule 6240 (Prohibition from Locking or Crossing Quotations in NMS 
Stocks), which generally requires members to avoid displaying, or 
engaging in a pattern or practice of displaying, any quotations that 
lock or cross a protected quotation, and any manual quotations that 
lock or cross a quotation previously disseminated pursuant to an 
effective NMS Plan.
    Consistent with the principles of Regulation NMS's locking and 
crossing restrictions, FINRA is proposing to require that members 
implement policies and procedures that reasonably avoid the display of, 
or engaging in a pattern or practice of displaying, locking or crossing 
quotations in any OTC Equity Security within the same inter-dealer 
quotation system.\9\ FINRA believes that the proposed policies and 
procedures approach is appropriate for addressing locked and crossed 
quotations in this market in light of the differences inherent in the 
quoting and trading of OTC Equity Securities as compared to NMS stocks.
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    \9\ Because there currently is not a mandated consolidated 
quotation dissemination mechanism for OTC Equity Securities as 
exists with NMS stocks, the proposed rule only restricts locking and 
crossing quotations within inter-dealer quotation systems, but not 
across inter-dealer quotations systems.
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    As the SEC noted in the Regulation NMS Adopting Release with 
respect to the adoption of Rule 610(d), FINRA also recognizes that a 
member's quotations may, on occasion, accidentally lock or cross 
another member's quotations. Thus, similar to Rule 6240, FINRA would 
expect that members' policies and procedures would require the quoting 
participant to make ``reasonable efforts'' to first contact or route an 
order to execute against the full displayed size of any quotation 
before locking and crossing that quotation. For example, a member firm 
may also include so-called ``ship and post'' procedures that require 
such firm to attempt to execute against a relevant displayed quotation 
while posting a quotation that could lock or cross such a quotation. In 
addition, members' policies and procedures must be reasonably designed 
to enable the reconciliation of locked or crossed quotations, including 
requiring the member to take reasonable action to resolve the locked or 
crossed market when such member is responsible for displaying the 
locking or crossing quotation. FINRA believes that implementation of 
policies and procedures to avoid locking and crossing quotations, in 
conjunction with members' existing obligation to honor posted 
quotations pursuant to NASD Rule 3320 (Offers at Stated Prices) and 
NASD IM-3320 (Firmness of Quotations), will facilitate more fair and 
orderly markets and support market efficiency.

D. Access Fee Cap

    FINRA is proposing a new rule to prohibit members from imposing 
non-subscriber access or post-transaction fees against published 
quotations in any OTC Equity Security that exceed or accumulate to more 
than specified amounts.
    Currently, FINRA Rule 6540(c) requires that an ATS or ECN reflect 
non-subscriber access or post-transaction fees in the ATS's or ECN's 
posted quote in the OTC Bulletin Board montage. There are no 
restrictions on ATS or ECN access fees displayed in other inter-dealer 
quotation systems, such as the Pink Sheets. FINRA is proposing to 
eliminate the requirement that members reflect access fees in OTCBB 
posted quotations, and to replace that requirement with a uniform 
access fee cap, consistent with Rule 610(c) of Regulation NMS. The 
proposed fee cap, as set forth in proposed Rule 6450, would restrict 
access fees in all OTC Equity Securities that exceed or accumulate to 
more than the following limits:
    a. If the price of the quotation is $1.00 or more, the fee or fees 
cannot exceed or accumulate to more than $0.003 per share; or
    b. If the price of the quotation is less than $1.00, the fee or 
fees cannot exceed or accumulate to more than 0.3% of the quotation 
price per share.\10\
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    \10\ These standards are substantially similar to the access fee 
restrictions in Regulation NMS. See Regulation NMS Adopting Release. 
Note, however, that the restrictions under Rule 610(c) of Regulation 
NMS are limited to ``protected quotations,'' for which there is no 
comparable designation in the OTC equity market. Instead, the 
proposal would apply the restrictions uniformly to all quotations 
displayed in the OTC equity market.
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    Also consistent with Regulation NMS, the proposal would codify that 
market makers, as well as ATSs, are permitted to charge access fees 
within the framework of the proposed access fee cap.
    Consistent with the SEC's conclusions in adopting Regulation NMS, 
FINRA believes that capping access fees is the most effective approach 
of the available alternatives, as well as the least disruptive to 
current market practice (other alternatives include an access fee 
display requirement and an outright prohibition on access fees). As the 
SEC stated in the Regulation NMS Adopting Release, a single, uniform 
fee limitation of $0.003 per share is the fairest and most appropriate 
resolution of the access fee issue. First, it will not seriously 
interfere with current business practices because trading centers have 
very few fees on their books of more than $0.003 per share and do not 
earn substantial revenues from such fees. In addition, a uniform fee 
limitation promotes equal regulation of different types of trading 
centers, where previously some had been permitted to charge fees and 
some had not. The SEC also noted that if wide disparities in access 
fees were permitted, the prices of quotations would be less useful and 
accurate. Therefore, a limitation on the level of access fees addresses 
the potential distortions caused by substantial, disparate fees.

E. Limit Order Display

    Rule 604 of Regulation NMS requires the immediate display of 
customer limit orders. Specifically, Regulation NMS requires the 
display of (1) the price and

[[Page 43209]]

the full size of each customer limit order that is at a price that 
would improve the bid or offer of the specialist or OTC market maker in 
such security; and (2) the full size of each customer limit order held 
by the specialist or OTC market maker that: Is priced equal to the bid 
or offer of such specialist or OTC market maker for such security; is 
priced equal to the national best bid or national best offer; and 
represents more than a de minimis change in relation to the size 
associated with the specialist or OTC market maker's bid or offer.
    FINRA is proposing to impose a similar requirement on customer 
limit orders in OTC Equity Securities, specifically, a market maker 
displaying a priced quote would be required to immediately \11\ display 
customer limit orders that it receives that (1) improve the price of 
the bid or offer displayed by the market maker, or (2) improve the size 
of its bid or offer by more than a de minimis amount where it is the 
best bid or offer in the inter-dealer quotation system where the market 
maker is quoting.\12\ Regulation NMS includes several exceptions from 
its limit order display requirements, which also would apply to the 
proposed limit order display rule for OTC Equity Securities. Thus the 
proposed rule would except any customer limit order:
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    \11\ Under Rule 604 of Regulation NMS, the requirement to 
``publish immediately'' a customer limit order requires the display 
(or execution or re-routing) of customer limit orders as soon as is 
practicable after receipt which, under normal market conditions, 
would require display no later than 30 seconds after receipt. See 
Securities Exchange Act Release No. 37619A, 61 FR 48290 (September 
12, 1996). FINRA proposes to adopt this same interpretation with 
respect to the timing of display of customer limit orders in OTC 
Equity Securities.
    \12\ Under Rule 604 of Regulation NMS, a customer limit order 
should be considered de minimis if it is less than or equal to 10% 
of the displayed size associated with a specialist's or OTC market 
maker's bid or offer and FINRA proposes to adopt this same 
interpretation with respect to the proposed rule. See Exchange Act 
Release No. 37619A, 61 FR 48290 (September 12, 1996).
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    a. That is executed upon receipt of the order.
    b. That is placed by a customer who expressly requests that the 
order not be displayed.
    c. That is an odd-lot order.\13\
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    \13\ As discussed in Trade Reporting Notice 3/18/08, with 
respect to OTC Equity Securities trading at $175 or more per share, 
FINRA has designated the ``unit of trade'' as one share rather than 
100 shares for purposes of public dissemination. As such, trades in 
these securities for fewer than 100 shares are not considered ``odd-
lot transactions'' and are disseminated by FINRA. However, for all 
other purposes, including the amendments proposed herein, 
transactions and orders of fewer than 100 shares are considered 
``odd lots,'' unless otherwise specifically determined by FINRA.
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    d. That is a block size order, unless a customer placing such order 
requests that the order be displayed.\14\
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    \14\ Under Regulation NMS, a ``block size'' with respect to an 
order means it is: (i) of at least 10,000 shares or (ii) for a 
quantity of stock having a market value of at least $200,000. 
Because of the lower average trade prices (and corresponding higher 
average total share amount) of orders in OTC Equity Securities, 
FINRA believes that a 10,000 share standard alone would exclude 
customer limit orders that should otherwise be displayed. Therefore, 
FINRA is proposing that the definition of ``block size'' under the 
rule for OTC Equity Securities be an order that is: (i) Of at least 
10,000 shares and (ii) has a market value of at least $100,000. This 
is consistent with the large order size exception under IM-2110-2 
(Trading Ahead of Customer Limit Order).
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    e. That is delivered immediately upon receipt to a national 
securities exchange or an electronic communications network that widely 
disseminates such order and immediately provides to an inter-dealer 
quotation system the prices and sizes of the orders at the highest buy 
price and the lowest sell price for such security.\15\
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    \15\ FINRA also is proposing to exclude from Rule 2320(g)(2) 
those priced quotations that represent a customer limit order 
displayed on an electronic communications network in conformance 
with this proposed exception. Rule 2320(g)(2) requires that members 
display the same priced quotation in a non-exchange-listed security 
when quoting in two or more quotation mediums.
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    f. That is delivered immediately upon receipt to another OTC market 
maker that complies with the proposed limit order display requirements 
with respect to that order.
    g. That is an all-or-none order.
    In adopting the limit order display requirements for NMS stocks, 
the SEC stated that the display of limit orders is designed, among 
other objectives, to publicize accurate market interest and increase 
quote competition. While the SEC recognized that the rule may lead to 
reduced spreads and a diminution in market maker profits per trade, the 
SEC also noted that narrower spreads could result in increased customer 
orders and volume over time and thus, ultimately improve liquidity. 
FINRA believes that extending limit order display requirements to OTC 
Equity Securities will improve transparency in the OTC equity market. 
In addition, as has been stated by the SEC, the display of customer 
limit orders advances the goal of the public availability of quotation 
information, as well as fair competition, market efficiency, best 
execution and disintermediation.
    Because the proposed new rules provide for significant regulatory 
changes, FINRA plans to implement the requirements in two phases to 
minimize the impact on firms. Phase one would implement sub-penny 
quoting restrictions, an access fee cap and restrictions on locked and 
crossed markets. Phase two would implement customer limit order display 
requirements. FINRA will announce the implementation dates for the 
proposed rule change in a Regulatory Notice to be published no later 
than 90 days following Commission approval. The implementation date of 
Phase one will be at least 120 days but no more than 365 days from the 
date of Commission approval and Phase two will be at least 90 days 
following the implementation of Phase one, but no more than 365 days 
from 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,\16\ which requires that 
FINRA rules must be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, processing information with respect to, 
and facilitating transactions in securities, 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.
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    \16\ 15 U.S.C. 78o-3(b)(6).
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    FINRA further believes that the proposed rule change is consistent 
with the provisions of 15A(b)(11) of the Act,\17\ which requires, among 
other things, that FINRA rules must govern the form and content of 
quotations relating to securities sold otherwise than on a national 
securities exchange and require that such rules relating to quotations 
shall be designed to produce fair and informative quotations, to 
prevent fictitious or misleading quotations, and to promote orderly 
procedures for collecting, distributing, and publishing quotations.
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    \17\ 15 U.S.C. 78o-3(b)(11).
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    FINRA is proposing to: (1) Restrict subpenny quoting; (2) restrict 
locked and crossed markets; (3) implement a cap on access fees; and (4) 
require the display of customer limit orders. FINRA believes that the 
proposed restrictions on sub-penny quoting will promote greater price 
transparency and consistency, reduce the potential harms associated 
with sub-penny quoting in OTC equity securities and improve the depth 
and liquidity of this market.
    FINRA believes that locked and crossed markets can cause confusion 
among investors concerning trading interest in a stock and that 
restricting the practice of submitting locking or

[[Page 43210]]

crossing quotations will enhance the usefulness of quotation 
information in the over-the-counter market, facilitate more fair and 
orderly markets and support market efficiency.
    Where wide disparities in access fees are permitted, the prices of 
quotations are less useful and accurate. Therefore, FINRA believes that 
a cap on access fees would improve the usefulness and accuracy of 
quotations and address the potential distortions caused by substantial, 
disparate fees. Finally, FINRA believes that applying limit order 
display requirements to OTC Equity Securities would improve 
transparency in the OTC equity market and advance the goal of the 
public availability of quotation information, as well as fair 
competition, market efficiency, best execution and disintermediation.
    FINRA believes that the proposed extension of the specified 
Regulation NMS protections to quoting and trading in OTC Equity 
Securities will prevent fraudulent and manipulative acts and practices 
in this market, promote just and equitable principles of trade, and 
protect investors and the public interest.

 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 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-2009-054 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2009-054. 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 such 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 publicly available. All 
submissions should refer to File Number SR-FINRA-2009-054 and should be 
submitted on or before September 16, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-20532 Filed 8-25-09; 8:45 am]

BILLING CODE 8010-01-P