Document ID: SEC-2011-0166-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2011-02-04T05:00Z

[Federal Register Volume 76, Number 24 (Friday, February 4, 2011)]
[Notices]
[Pages 6500-6503]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-2492]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63799; File No. SR-FINRA-2010-053]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting 
Accelerated Approval of a Proposed Rule Change Relating to Amendments 
to the Panel Composition Rule, and Related Rules, of the Code of 
Arbitration Procedure for Customer Disputes

January 31, 2011.

I. Introduction

    On October 25, 2010, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposal to amend the panel composition rule, and related rules, of the 
Code of Arbitration Procedure for Customer Disputes (``Customer 
Code''),\3\ to provide customers with the option to choose an all 
public arbitration panel in all cases. The proposed rule change was 
published for comment in the Federal Register on November 12, 2010.\4\ 
The Commission received 125 comments on the proposed rule change.\5\ Of 
the comments received, 103 commenters support the proposal as filed, 21 
commenters support the proposal with suggested modifications, and one 
commenter opposes the proposal. On December 16, 2010, FINRA responded 
to comments and filed Amendment No. 1 to the proposed rule change.\6\ 
The Commission is publishing this notice and order to solicit comment 
on Amendment No. 1 and to approve, on an accelerated basis, the 
proposal as modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ FINRA Manual, Rule 12000, et seq., available on FINRA's Web 
site, http:www.finra.org.
    \4\ See Securities Exchange Act Release No. 63250 (Nov. 5, 
2010), 75 FR 69481 (Nov. 12, 2010) (``Notice'').
    \5\ The comment period ended on December 3, 2010; all comments 
are posted on the Commission's Web site, http://www.sec.gov/rules/sro.shtml.
    \6\ See Response to Comments and Amendment No. 1. The text of 
the proposal and Response to Comments and Amendment No. 1 are 
available on FINRA's Web site, http:www.finra.org, at the principal 
office of FINRA, and on the Commission's Web site, http://www.sec.gov/rules/sro.shtml. Amendment No. 1 imposes an additional 
notice requirement from FINRA to customers, provides minor 
clarifications regarding FINRA's original intent for the scope of 
the rule change, and makes other minor technical edits. FINRA 
identifies and discusses the particular commenters that support, 
request modification and oppose the proposal in its Response to 
Comments and Amendment No. 1. For the purposes of this Order, we 
will use the same designations for the commenters that are used by 
FINRA in that response.
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II. Description of the Proposed Rule Change as Modified by Amendment 
No. 1

    FINRA proposed to amend the panel composition rule, and related 
rules, of the Customer Code to provide customers with the option to 
choose an all public arbitration panel in all cases.

A. Background

    Under the Customer Code, parties in arbitration participate in 
selecting the arbitrators who serve on their cases. For customer claims 
of more than $100,000, the Customer Code currently provides for a three 
arbitrator panel \7\ comprised of a chair-qualified public 
arbitrator,\8\ a public arbitrator,\9\ and a non-public arbitrator 
(``Majority Public Panel'').\10\ FINRA uses its computerized Neutral 
List Selection System (``NLSS'') to generate random lists of 10 
arbitrators from each of these categories.\11\ The parties select their 
panel through a process of striking and ranking the arbitrators on the 
lists generated by NLSS. The Customer Code permits the parties to 
strike the names of up to four arbitrators from each list. The parties 
then rank the arbitrators remaining on the lists in order of 
preference. FINRA appoints the panel from among the names remaining on 
the lists that the parties return.
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    \7\ Rule 12401 provides for a single, chair-qualified public 
arbitrator if the amount of the claim is not more than $100,000. It 
provides for a three arbitrator panel if the amount of a claim is 
more than $100,000, or is unspecified, or if the claim requests non-
monetary damages. The parties, in claims of more than $25,000, but 
not more than $100,000, may agree in writing to have a three 
arbitrator panel.
    \8\ Rule 12400(c) specifies the criteria for arbitrator 
inclusion on the chairperson roster.
    \9\ Rule 12100(u) specifies the criteria FINRA uses to classify 
arbitrators as public.
    \10\ Rule 12100(p) specifies the criteria FINRA uses to classify 
arbitrators as non-public.
    \11\ Rule 12400.
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B. FINRA's Public Arbitrator Pilot Program

    In order to address the perception that FINRA's mandatory inclusion 
of a non-public arbitrator (often referred to as the ``industry'' 
arbitrator) in the Majority Public Panel is not fair to customers, 
FINRA launched a pilot program (``the Pilot'') that allows parties to 
choose a panel of three public arbitrators instead of two public 
arbitrators and one non-public arbitrator (``Optional All Public 
Panel'').
    FINRA designed the Pilot to run for two sequential years (``Year 
One'' and ``Year Two''), beginning October 6, 2008, and ending October 
5, 2010. In Year One, 11 brokerage firms volunteered to participate in 
the Pilot, each contributing a set number of cases to the Pilot per 
year for two years. In Year Two, FINRA expanded the number of 
participating brokerage firms to 14 firms. In addition, several of the 
original participants increased their respective case commitments for 
Year Two. Participating firms agreed to extend the Pilot for a third 
year at the same case levels as Year Two, while FINRA proceeds with the 
current rulemaking process. Year Three of the Pilot began October 6, 
2010, and ends October 5, 2011, or upon implementation of this proposed 
rule change, whichever comes first.
    Under the Pilot, only a customer may decide whether his or her case 
should proceed under Pilot rules; the participating firms cannot select 
the Pilot cases. Under the Pilot rules, the parties receive the same 
three lists of proposed arbitrators that parties in non-Pilot cases 
receive. However, in the Pilot cases, any party can strike up to four 
arbitrators on the chair-qualified public arbitrator list, up to four 
arbitrators on the public arbitrator list, as well as all of the 
arbitrators on the non-public list. After striking arbitrators from the 
lists, the parties will rank the remaining arbitrators in order of 
preference and FINRA will appoint the panel from among the names 
remaining on the lists that the parties return. By striking all the 
arbitrators on the non-public list, any party may ensure a panel of 
three public arbitrators.
    FINRA stated that reactions from participants in the Pilot indicate 
that customer representatives strongly support the right of customers 
to decide whether to exclude any non-public arbitrator.\12\ That 
feedback led FINRA to propose amending the panel composition rule for 
customer cases to follow the Pilot model, and to allow the customer 
party to choose between the existing panel selection method and the 
method used in the Pilot. Unlike the Pilot, however, the proposed rule 
would apply to all customer disputes against

[[Page 6501]]

any firm and any registered representative.
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    \12\ During the Pilot FINRA conducted surveys, focus groups, and 
met with customer representatives from the Securities Industry 
Conference on Arbitration and FINRA's National Arbitration and 
Mediation Committee.
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C. Details of the Proposed Rule Change

    FINRA based the proposed rule change on its experience with the 
Pilot. Under the proposed rule change, a customer could elect either 
arbitrator selection method within 35 days from service of the 
Statement of Claim. If the customer declined to make an affirmative 
election by the 35-day deadline, FINRA would apply the composition rule 
for the existing Majority Public Panel.
    Under either panel selection option, the parties would receive 
three lists--one with 10 chair-qualified public arbitrators, one with 
10 public arbitrators, and one with 10 non-public arbitrators. The 
parties would select their panel through a process of striking and 
ranking the arbitrators on the lists. Under the Majority Public Panel 
method, FINRA would permit each party to strike up to four arbitrators 
on the chair-qualified public, public, and non-public lists, leaving at 
least six arbitrator names remaining on each party's list. Under the 
Optional All Public Panel, any party may strike up to four arbitrators 
on the chair-qualified public and public lists, but may also strike all 
proposed non-public arbitrators and thereby effectively choose a panel 
of three public arbitrators.
    Currently, six rules enumerate the procedures for selecting, 
appointing, and replacing arbitrators.\13\ FINRA proposed to 
consolidate these six rules into two new rules: New Rule 12402 relating 
to customer cases with one arbitrator, and new Rule 12403 relating to 
customer cases with three arbitrators.\14\ New Rule 12402 would 
describe the procedures for selecting, appointing, and replacing the 
arbitrator in a single arbitrator case. New Rule 12403 would describe 
the two options that customers have for selecting arbitrators and would 
include the procedures for appointing and replacing arbitrators. The 
proposed rule change would apply to all customer cases.
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    \13\ Rule 12402 (Composition of Arbitration Panels) specifies 
the panel composition for all customer cases. Rules 12403 
(Generating and Sending Lists to the Parties), 12404 (Striking and 
Ranking Arbitrators), 12405 (Combining Lists), 12406 (Appointment of 
Arbitrators; Discretion to Appoint Arbitrators Not on List), and 
12411 (Replacement of Arbitrators) enumerate the procedures for 
selecting, appointing, and replacing arbitrators.
    \14\ FINRA would delete current Rules 12402, 12403, 12404, 
12405, 12406, and 12411 in their entirety. FINRA would renumber the 
remaining rules in the 12400 series so that the numbering would 
remain consecutive after FINRA consolidated the rules.
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III. Summary of Comments

A. Customer Election of Panel Composition Method

    Some commenters suggested that the Optional All Public Panel method 
of panel composition should be the default instead of the Majority 
Public Panel method.\15\ Commenters also raised concerns that customers 
without attorneys (``pro se'' claimants), or attorneys new to the 
practice of securities arbitration, might not elect the Optional All 
Public Panel method within the prescribed deadline, or might not 
appreciate the benefit of electing this method.\16\ One commenter 
stated that pro se claimants may be confused by receiving a list of 
non-public arbitrators after making the election for the Optional All 
Public Panel method.\17\ Another commenter suggested that, if a 
customer elects to proceed with the Optional All Public Panel method of 
panel composition, the parties should only receive lists of public 
arbitrators (i.e., they should not receive a list of non-public 
arbitrators).\18\ Finally, two commenters asked FINRA to clarify 
whether customers may make their panel composition election at the time 
of filing the Statement of Claim.\19\
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    \15\ See Haigney comment, Sutherland comment, Black and Gross 
comment, Berg comment, PIABA comment; St. John's comment; and NASAA 
comment.
    \16\ See Haigney comment.
    \17\ See NASAA comment. The comment also suggests that FINRA 
change the ``majority public panel'' option label to ``mixed 
affiliation'' and that FINRA describe the term ``non-public 
arbitrator'' as ``industry-affiliated.'' In its response to 
comments, FINRA stated that the Majority Public Panel label clearly 
describes the panel composition and that changing the term ``non-
public'' at this point would cause confusion.
    \18\ See Berg comment.
    \19\ See the Haigney comment and the PIABA comment.
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    FINRA responded to these comments by stating that it believes it is 
appropriate to have customers elect the Optional All Public Panel 
method rather than having that option as the default.\20\ During the 
Pilot, a substantial percentage of customers opted for a Majority 
Public Panel. From launch of the Pilot in October 2008, until December 
1, 2010, in 74 percent of cases eligible for the Pilot, customers 
accepted a non-public arbitrator on their panel either by choosing not 
to participate in the Pilot or by ranking one or more non-public 
arbitrators.\21\ FINRA stated that there were very few complaints from 
customers that they were not aware of the Pilot and that it is 
appropriate to have customers elect, rather than be defaulted to, the 
Optional All Public Panel method.\22\
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    \20\ See Response to Comments and Amendment No. 1, supra, note 
6.
    \21\ Id.
    \22\ Id.
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    While FINRA indicated that the percentage of pro se claimants that 
file arbitration claims over $100,000 at FINRA is very small, to 
respond to the commenters' concerns relating to pro se claimants and to 
attorneys new to the practice of securities arbitration, FINRA is 
proposing to amend the proposed rule change to state that FINRA will 
notify the customer in writing that the customer has 35 days from 
service of the Statement of Claim to elect the Optional All Public 
Panel method. Further, FINRA will highlight the rule change in its case 
filing instructions, website information, and other materials, as 
applicable. FINRA stated that it believes that amending the proposed 
rule change to add a customer notification provision and highlighting 
in its written materials how the panel composition methods work will 
ensure that customers understand how to elect the Optional All Public 
Panel method and are aware of the applicable deadlines for election. 
FINRA also stated that during the Pilot, a substantial percentage of 
customers opted for a majority public panel and for this reason did not 
change the selection process in the proposal.
    With regard to the comment that customers electing the Optional All 
Public Panel receive three lists of public arbitrators, FINRA stated 
that given the data FINRA compiled from the Pilot, it did not at this 
time find persuasive the comments requesting that customers receive a 
list only of public arbitrators.\23\
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    \23\ See Response to Comments and Amendment No. 1, supra, note 
6.
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    FINRA also stated that it intends to allow customers to make their 
election of the Optional All Public Panel in the Statement of Claim (or 
correspondence accompanying the Statement of Claim) in instances when 
the customers are claimants.\24\ Therefore, FINRA is proposing to amend 
the proposed rule change to state that the customer may elect in 
writing to proceed under either the composition rules for the Majority 
Public Panel or the composition rules for the Optional All Public Panel 
in the customer's Statement of Claim, if the customer is a claimant, or 
at any time up to 35 days from service of the Statement of Claim, 
whether the customer is a complainant or respondent.
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    \24\ Id.
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    In addition, FINRA is proposing to correct an error in the title of 
proposed Rule 12403(b) which, as proposed, states ``Customer Claimant 
Election.'' FINRA proposes to amend the title to

[[Page 6502]]

eliminate the reference to ``Claimant'' because a customer may be a 
respondent in FINRA arbitration and FINRA intends the proposed rule 
change to apply to all customer disputes regardless of whether 
customers are claimants or respondents.

B. Effect of Proposed Rule Change on Individually Named Registered 
Representatives

    The proposed rule change would apply to all firms and all 
registered representatives. One commenter opposed applying the proposed 
rule change to individually named registered representatives.\25\ 
According to the commenter, FINRA should provide registered 
representatives with the procedural protection of having a non-public 
arbitrator on their arbitration panel. FINRA stated that it believes 
that the commenter's suggestion is unworkable.\26\ If FINRA does not 
apply the proposed rule change to individually named registered 
representatives, customers that wish to proceed under the Optional All 
Public Panel method for their claims against firms would be compelled 
to bifurcate their claims against firms from their claims against 
registered representatives. Moreover, if the firm wishes to assert a 
third party claim against a registered representative in a customer 
case where a customer elected the Optional All Public Panel composition 
method, the firm's claim could interfere with the customer's election 
of the Optional All Public Panel. Finally, FINRA believes that 
bifurcation of customers' claims is likely to result in higher overall 
arbitration costs for customers. FINRA, thus, concluded that the 
consequences of the commenter's suggestion would make the suggestion 
inefficient and impractical.
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    \25\ See SIFMA comment.
    \26\ See Response to Comments and Amendment No. 1, supra, note 
6.
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C. Inclusion of a Non-Public Arbitrator

    Two commenters stated that inclusion of a non-public arbitrator 
would benefit all the parties to a dispute, as well as the public 
arbitrators on the panel, by appropriately educating them about 
industry-related issues.\27\ One commenter stated that the non-public 
arbitrator may also reduce costs for the parties by limiting the need 
for the parties to call expert witnesses.\28\
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    \27\ See SIFMA comment and Wacht comment.
    \28\ See SIFMA comment.
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    In contrast, a number of commenters stated that parties frequently 
use expert witnesses in cases with majority public panels, which limits 
the need for the non-public arbitrator's industry expertise and any 
potential cost savings.\29\
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    \29\ See Neuman comment, Shewan comment, Banks comment, and 
Rosenberg comment.
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    Under the Pilot and the amended rules, customers who do not elect 
the Optional All Public Panel selection method, will continue to have a 
panel that includes a non-public arbitrator. FINRA stated that it 
received feedback on the Pilot from both investor and industry 
attorneys that indicates that panel composition made no difference in 
how parties used experts to try their cases.\30\ In addition, a number 
of commenters expressed concerns about the non-public arbitrator 
offering expert opinions to the other arbitrators where those opinions 
would not be subject to cross-examination.\31\ Regarding the comments 
that a non-public arbitrator may act as an expert witness not subject 
to cross-examination, FINRA stated that it believes that the proposed 
rule mitigates the concern because any customer that shares this 
concern may elect the Optional All Public Panel.\32\ Therefore, FINRA 
did not amend the proposal as it relates to the non-public arbitrator.
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    \30\ See Response to Comments and Amendment No. 1, supra, note 
6.
    \31\ See Aidikoff comment, Coleman comment, Amato comment, 
Eccleston comment, Goldstein comment, Karen comment, Fogel comment, 
Cornell comment, Mihalek comment, PIABA comment, and NASAA comment.
    \32\ See Response to Comments and Amendment No. 1, supra, note 
6.
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D. Request To Reject the Proposed Rule Change

    One commenter requested that the Commission reject the proposed 
rule change as contrary to the public interest.\33\ The commenter 
stated that FINRA has other tools to correct the public's perception 
that FINRA arbitration is not fair to investors. FINRA stated that it 
believes that the results of the Pilot, the public's feedback on the 
program, and the overwhelming support reflected in the comments 
submitted on the proposed rule change support the need to provide 
customers with the choice of whether to select an Optional All Public 
Panel or a Majority Public Panel.\34\
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    \33\ See Wacht comment.
    \34\ See Response to Comments and Amendment No. 1, supra, note 
6.
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E. Comments Outside the Scope of the Proposed Rule Change

    Commenters raised a number of additional issues, including concerns 
regarding mandatory arbitration of investor disputes; \35\ the 
definition of ``public arbitrator''; \36\ investor arbitration fees; 
\37\ the discovery process at FINRA; \38\ the NLSS; and blue sky 
laws.\39\ Stating that all of these comments are outside of the scope 
of the proposed rule change, FINRA declined to make changes to address 
them.\40\ FINRA also stated that it believes its arbitration forum is 
fair, and highlighted that it does not require firms to use pre-dispute 
arbitration clauses.\41\
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    \35\ See: Layne comment, Steiner comment, Chalmers comment, 
Gladden comment, Estell comment, Sutherland comment, Furgison 
comment, Healy comment, Samson comment, Berg comment, Miller 
comment, Ilgenfritz comment, Rosenfield comment, Bleecher comment, 
Mihalek comment, and NASAA comment.
    \36\ See Goldstein comment.
    \37\ See Layne comment.
    \38\ See Layne comment and Estell comment.
    \39\ See Estell comment.
    \40\ See Response to Comments and Amendment No. 1, supra, note 
6.
    \41\ Id.
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IV. Discussion and Finding

    After carefully reviewing the proposed rule change, the comment 
letters, and FINRA's Response to Comments and Amendment No. 1, the 
Commission finds that the proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities association.\42\ In particular, the 
Commission believes that the proposed rule change, as amended, is 
consistent with the provisions of Section 15A(b)(6) of the Act, 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.\43\ The Commission believes the 
proposed rule change, as amended, will enhance the public's perception 
that the FINRA securities arbitration process and rules are fair and 
would promote just and equitable principles of trade by giving 
investors additional choices regarding the composition of panels that 
will hear their cases. This, in turn, should help enhance public 
confidence in, and perception of, the fairness of the FINRA arbitration 
forum. We understand that FINRA plans to implement this rule change as 
soon as possible to provide this option to as many customers as 
possible.
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    \42\ In approving the proposed rule change, the Commission has 
considered the rule change's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \43\ See 15 U.S.C. 78o-3(b)(6).
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V. Accelerated Approval

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the

[[Page 6503]]

Act,\44\ for approving the proposed rule change, as amended, prior to 
the 30th day after the date of publication in the Federal Register. The 
changes proposed in Amendment No. 1 do not raise novel regulatory 
concerns. Moreover, accelerating approval of this proposal should 
benefit investors by providing customers with the immediate option to 
select an all public arbitration panel for all cases. Accordingly, the 
Commission finds that good cause exists to approve the proposal, as 
modified by Amendment No. 1, on an accelerated basis.
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    \44\ 15 U.S.C. 78s(b)(2).
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VI. 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-2010-053 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-2010-053. 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 Web site 
viewing and printing 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 available 
publicly. All submissions should refer to File Number SR-FINRA-2010-053 
and should be submitted on or before February 25, 2011.

VII. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\45\ that the proposed rule change (SR-FINRA-2010-053), as modified 
by Amendment No. 1, be, and hereby is, approved on an accelerated 
basis.
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    \45\ 15 U.S.C. 78s(b)(2).
    \46\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\46\
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-2492 Filed 2-3-11; 8:45 am]
BILLING CODE 8011-01-P