Document ID: SEC-2010-1452-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2010-09-23T04:00Z

[Federal Register: September 23, 2010 (Volume 75, Number 184)]
[Notices]               
[Page 58007-58011]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23se10-113]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-62930; File No. SR-FINRA-2010-036]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change to Amend the 
Codes of Arbitration Procedure to Permit Arbitrators to Make Mid-case 
Referrals

September 17, 2010.
    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 July 12, 2010, 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 substantially 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 broaden an arbitrators' authority to make 
referrals during an arbitration proceeding by amending Rule 12104 of 
the Code of Arbitration Procedure for Customer Disputes (``Customer 
Code'') and by creating new Rule 12902(e) to address the assessment of 
hearing session fees, costs, and expenses if an arbitrator

[[Page 58008]]

makes a referral during a case that results in panel withdrawal. 
Similarly, the proposal would amend Rule 13104 of the Code of 
Arbitration Procedure for Industry Disputes (``Industry Code'') to 
broaden an arbitrators' authority to make referrals during an 
arbitration proceeding and create new Rule 13902(e) to address the 
assessment of hearing session fees, costs and expenses if an arbitrator 
makes a referral during a case that results in panel withdrawal.
    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
Background
    In light of recent well-publicized securities frauds that resulted 
in harm to investors, FINRA has reviewed its rule on arbitrator 
referrals and determined that it should be amended to permit 
arbitrators to make referrals during an arbitration proceeding--rather 
than solely at the conclusion of a matter as is currently the case--
when the arbitrator has reason to believe there is a serious, ongoing, 
imminent threat to investors that requires immediate action.
    Currently, Rule 12104(b) of the Customer Code and Rule 13104(b) of 
the Industry Code (together, Codes), state, in relevant part, that any 
arbitrator may refer to FINRA for disciplinary investigation any matter 
that has come to the arbitrator's attention during and in connection 
with the arbitration only at the conclusion of an arbitration (emphasis 
added). FINRA believes that restricting arbitrators from making 
referrals until the conclusion of an arbitration may hamper FINRA's 
efforts to uncover fraud as early as possible.
    FINRA is proposing, therefore, to broaden the arbitrators' 
authority under the Codes to make referrals during the prehearing, 
discovery, or hearing phase of an arbitration. Specifically, FINRA 
would amend Rules 12104 and 13104 of the Codes to permit referrals to 
the Director\3\ during the prehearing, discovery, or hearing phase of 
an arbitration proceeding, when the arbitrators have reason to believe 
that any matter or conduct poses a serious, ongoing, imminent threat to 
investors that requires immediate action. Further, FINRA would add new 
Rules 12902(e) and 13902(e) of the Codes to address the assessment of 
hearing session fees, costs, and expenses when an arbitrator referral 
during a case results in the withdrawal of the panel.
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    \3\ The term Director means the Director of FINRA Dispute 
Resolution, and includes FINRA staff to whom the Director has 
delegated authority. See Rule 12100(k) of the Customer Code and Rule 
13100(k) of the Industry Code.
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Explanation of the Proposed Rule Change
    Changes to the Customer Code
Rule 12104--Effect of Arbitration on FINRA Regulatory Activities
    First, FINRA proposes to add the phrase ``Arbitrator Referral 
During or at Conclusion of Case'' to the title of Rule 12104 so that it 
reflects accurately the proposed changes. The new title would read: 
``Effect of Arbitration on FINRA Regulatory Activities; Arbitrator 
Referral During or at Conclusion of Case.''
    Second, the current rule would be rearranged to reflect the order 
in which an arbitrator may make a referral in an arbitration case. 
Subparagraph (a) would remain unchanged. The provision in current 
subparagraph (b) of the rule, which addresses arbitrator referrals made 
only at the conclusion of the case (hereinafter, ``the post-case 
referral provision''), would be amended and moved to new subparagraph 
(e). In its place, FINRA would insert new rule language in subparagraph 
(b) to address arbitrator referrals made during the prehearing, 
discovery, or hearing phase of an arbitration (hereinafter, ``the mid-
case referral provision''). New subparagraph (c) would require 
arbitrator disclosure of a mid-case referral and withdrawal of the 
panel upon a party's request. New subparagraph (d) would address the 
administration of the case using a new panel. And finally, new 
subparagraph (e) would contain the rule language in current 
subparagraph (b) with some amendments to address post-case referrals.
Rule 12104(b)--Mid-case Referral Provision
    Rule 12104(b) would be amended to state that any arbitrator may 
refer to FINRA any matter or conduct that has come to the arbitrator's 
attention during the prehearing, discovery, or hearing phase of a case, 
which the arbitrator has reason to believe poses a serious, ongoing, 
imminent threat to investors that requires immediate action. The 
proposed rule would state further that arbitrators should not make mid-
case referrals based solely on allegations in the statement of claim, 
counterclaim, cross claim, or third party claim.
    The new language of Rule 12104(b) would provide arbitrators with 
the express authority to alert the Director during a case when they 
learn of what they believe to be fraudulent activity that requires 
immediate action. This aspect of the rule would provide FINRA with a 
vital tool for detecting and minimizing the effects of potentially 
fraudulent activity as early as possible.\4\
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    \4\ The proposed rule would not preclude an arbitrator from 
notifying other departments of FINRA of its findings, as 
appropriate.
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    Specifically, under the new rule language, arbitrators would be 
authorized to make mid-case referrals based on what they learn during 
the prehearing, discovery, or hearing phase of a case. Moreover, 
arbitrators could not make mid-case referrals based solely on 
allegations in the statement of claim, counterclaim, cross claim, or 
third party claim. This means that the mid-case referral would not be 
based solely on the parties' pleadings.\5\ Because Dispute Resolution 
routinely provides copies of the arbitration claims to FINRA's 
Enforcement division, mid-case referrals based only on the pleadings 
are not necessary to apprise Enforcement of possible wrongdoing.\6\ But 
if arbitrators learn of information relating to a serious, ongoing, 
imminent threat during the pre-hearing, discovery or hearing phase of a 
case, the new rule would permit any arbitrator to make a mid-case 
referral to FINRA. This rule would ensure that arbitrators have the 
discretion to make a mid-case referral at the time they become aware of 
evidence or other information that they believe poses a serious, 
ongoing, imminent

[[Page 58009]]

threat to investors. Moreover, by providing that the arbitrators could 
not make a mid-case referral based solely on the pleadings, the rule 
would help avoid unnecessary mid-case referrals and the consequent 
disruption to an ongoing case.
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    \5\ A pleading is a statement describing a party's causes of 
action or defenses. Documents that are considered pleadings are: A 
statement of claim, an answer, a counterclaim, a cross claim, a 
third party claim, and any replies. Rule 12100(s) of the Customer 
Code and Rule 13100(s) of the Industry Code.
    \6\ Dispute Resolution provides copies of all statement of 
claims to Enforcement. Staff also provides to Enforcement copies of 
answers in disputes involving promissory notes, or responses to 
third party claims, counterclaims or cross claims.
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    The new language of Rule 12104(b) would also require that the 
matter or conduct that would be the subject of the mid-case referral 
should pose a serious, ongoing, imminent threat to investors that 
requires immediate action. Arbitrators should use their judgment in 
determining whether the matter or conduct poses such a threat before 
making a mid-case referral.
Rule 12104(c)--Arbitrator Disclosure and Withdrawal
    If any arbitrator makes a mid-case referral under proposed Rule 
12104(b), the Director will disclose to the parties the act of making 
such referral. Further, if a party requests that a referring arbitrator 
withdraw, the entire panel, at the time of the referral, must withdraw. 
A party must make the withdrawal request within 10 days of receipt of 
notice of the referral disclosure.
    First, after an arbitrator makes a mid-case referral, the Director 
would notify the parties of the referral. The Director will notify the 
parties of the referral because a referral of a potentially serious, 
ongoing, imminent threat to investors could cause a party to question 
the neutrality of the arbitrators going forward. After receiving this 
notification, any party may request that the panel,\7\ at the time of 
the referral, withdraw from the case upon the Director's disclosure of 
a mid-case referral.
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    \7\ Under Rules 12101(g) and 13101(g) of the Codes, the term 
``panel'' means the arbitration panel, whether it consists of one or 
more arbitrators.
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    Second, the proposed rule would require that a party make the 
withdrawal request within 10 days\8\ of receipt of notice of the 
disclosure. Once the parties learn of the mid-case referral, they 
should decide promptly whether to keep the panel or request its 
withdrawal.
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    \8\ Under Rules 12100(j) and 13100(j) of the Codes, the term 
``day'' means calendar day.
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Rule 12104(d)--Continuing the Arbitration Case With a New Panel
    Proposed Rule 12104(d) would address how FINRA would administer the 
arbitration case if a panel withdraws from the case and a new panel is 
selected by the parties.
    FINRA recognizes that the time required to select a new panel after 
the initial panel makes a mid-case referral could delay the resolution 
of the claimants' case. To minimize potential delays in continuing the 
case, FINRA Dispute Resolution staff (staff) will endeavor to complete 
the arbitrator selection process for the new panel, schedule the 
subsequent Initial Prehearing Conference, and serve the award on an 
expedited basis.\9\ In addition, while staff cannot shorten the time 
requirements set forth in the Codes, parties may agree to modify a 
provision of the Codes by written agreement of all named parties.\10\
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    \9\ FINRA launched a voluntary national program in June 2004 to 
expedite arbitration proceedings in matters involving senior or 
seriously ill parties. Thus, staff has considerable experience in 
expediting arbitration cases when necessary. See Notice to Parties--
Expedited Proceedings for Senior or Seriously Ill Parties, available 
at http://www.finra.org/ArbitrationMediation/Parties/
ArbitrationProcess/NoticesToParties/P009636.
    \10\ See Rules 12105(a) and 13105(a) of the Codes.
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    If the case moves forward, FINRA would administer the case as 
follows. First, FINRA would not close the case, but instead, would keep 
the original pleadings (i.e., the statement of claim, answer, and any 
other pleadings) and proceed with the case after party selection of a 
new panel under the Neutral List Selection System rules.
    Second, the new panel would schedule an Initial Prehearing 
Conference to set discovery, briefing, and motions deadlines, schedule 
subsequent hearing sessions, and address other preliminary matters.\11\ 
At this time, the new panel would also determine whether any orders or 
rulings from the original panel were still in effect, and these 
decisions would be final and binding on the parties.\12\
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    \11\ See Rules 12500(b) and 13500(b) of the Codes.
    \12\ See Rules 12413 and 13413 of the Codes.
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    Third, the new panel would determine whether to permit the 
introduction of evidence and the record of proceedings from prior 
hearing sessions in subsequent hearing sessions, pursuant to Rule 
12604(a).\13\ This would provide arbitrators with the discretion to 
permit access to and use of the record of proceedings from the hearing 
record, based on the needs of the parties and the relevance of the 
information in the hearing record. FINRA notes that parties would be 
permitted to object to the admissibility of this information, but the 
determination on admissibility would be within the panel's discretion.
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    \13\ See also Rule 13604(a) of the Industry Code.
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    The record of proceedings,\14\ hereinafter referred to as the 
hearing record, from the first case would not contain references to 
panel discussions about a mid-case referral. Such arbitrator 
deliberations are not contained in the hearing record because 
arbitrators discuss these types of issues in an executive session which 
is not recorded or made a part of the hearing record. As a result, the 
new arbitrators would not learn of the mid-case referral or its 
rationale from the hearing record of the prior hearing sessions.
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    \14\ See Rules 12606 and 13606 of the Codes.
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FINRA's Assessment of the Mid-case Referral Provision and its Potential 
Effects on an Arbitration Case
    The proposed rule would provide an additional tool to strengthen 
FINRA's regulation of its members. Though mid-case referrals likely 
would be rare, FINRA recognizes that such a referral would have an 
impact on an investor's \15\ arbitration case. If an arbitrator makes a 
mid-case referral and the panel withdraws, the customer's arbitration 
case would be delayed until the parties settle, continue, or begin the 
case anew, as discussed under Rule 12104(d). Further, a customer could 
incur additional costs as a result of a mid-case referral, such as 
attorney's fees. To minimize some of the additional expense that a 
customer could incur, FINRA is proposing to waive certain fees for the 
customer.\16\
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    \15\ In intra-industry cases, the impact could be on an 
associated person or on a member that is not the subject of the 
referral.
    \16\ See infra discussion under Rules 12902(e) and 13902(e).
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    Moreover, FINRA understands that the impact would be greatest on 
those customers whose hearings were almost completed. Thus, FINRA will 
caution arbitrators, in those instances, to weigh carefully the 
imminence of a possible threat to investors and the markets against the 
harm to the customer whose case would be disrupted. In close cases, 
FINRA suggests that arbitrators consider whether any time saved or harm 
averted by a mid-case referral warrants disrupting a customer's 
arbitration case. If the arbitrators conclude that disruption of the 
investor's case is not warranted, a referral at the end of the case may 
be more appropriate.
Rule 12104(e)--Post-case Referral Provision
    The language in current subparagraph (b) of the Rule 12104, which 
addresses arbitrator referrals made only at the conclusion of the case, 
would be amended and moved to new subparagraph (e).
    The current rule states that ``only at the conclusion of an 
arbitration, any arbitrator may refer to FINRA for disciplinary 
investigation any matter that has come to the arbitrator's attention 
during and in connection with the arbitration, either from the record 
of the proceeding or from material or

[[Page 58010]]

communications related to the arbitration, which the arbitrator has 
reason to believe may constitute a violation of NASD or FINRA rules, 
the federal securities laws, or other applicable rules or laws.''
    The proposal would permit arbitrators to continue making post-case 
referrals. However, FINRA would amend the rule to permit arbitrators to 
make a post-case referral to the Director, rather than to FINRA,\17\ so 
that the provisions of Rule 12104 are consistent. Further, FINRA would 
delete the term ``disciplinary'' to ensure that the scope of potential 
referrals is not limited to disciplinary findings, and would add the 
phrase ``or conduct,'' so that the subject-matter of Rule 12104 is 
consistent throughout the rule. The rule also would be amended to 
replace the reference to violations of ``NASD or FINRA rules'' with 
``the rules of FINRA'' because the current FINRA rulebook consists of 
FINRA Rules, NASD Rules, and incorporated NYSE Rules.
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    \17\ See notes 2 and 3.
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Rule 12902--Assessment of Hearing Session Fees, Costs, and Expenses if 
an Arbitrator Referral During a Case Results in Panel Withdrawal
    FINRA is proposing to adopt new Rule 12902(e) to address the 
assessment of hearing session fees, costs, and expenses if an 
arbitrator makes a referral during a case that results in panel 
withdrawal.
    First, FINRA recognizes the potential impact that the panel's 
withdrawal during the course of a hearing would have on the customer. 
Thus, FINRA is proposing new Rule 12902(e)(1) that would waive the 
customer's hearing session fees for the sessions conducted prior to the 
referral in an effort to reduce the potential financial impact.
    Second, under proposed new Rule 12902(e)(2), FINRA may waive any 
hearing session fees assessed against a member for hearing sessions 
conducted prior to the mid-case referral, if the member is not the 
subject of the referral. The proposed rule would provide FINRA with 
discretion to waive any hearing session fees assessed against a member 
that is named in the arbitration, but is not the subject of the mid-
case referral.
    Last, under proposed new Rule 12902(e)(3), FINRA would postpone any 
scheduled hearing sessions if a mid-case referral results in the 
withdrawal of the panel, so that a new panel would have flexibility to 
schedule new hearing sessions based on its availability. Thus, if any 
scheduled hearing sessions are postponed, FINRA would waive the 
postponement fees that would otherwise accrue.
Changes to the Industry Code
Rule 13104--Effect of Arbitration on FINRA Regulatory Activities
    FINRA also is proposing to amend Rule 13104 of the Industry Code to 
broaden the arbitrators' authority to make referrals during an 
arbitration proceeding in intra-industry cases. The reasons for the 
proposed changes to Rule 13104 are the same as those for Rule 12104 of 
the Customer Code discussed above.
Rule 13902--Assessment of Hearing Session Fees, Costs, and Expenses if 
an Arbitrator Referral During a Case Results in Panel Withdrawal
    FINRA also is proposing to adopt new Rule 13902(e) to address the 
assessment of hearing session fees, costs, and expenses on member firms 
and associated persons if an arbitrator makes a referral during a case 
that results in panel withdrawal.
    Under proposed new Rule 13902(e)(1), FINRA would waive the hearing 
session fees for sessions conducted prior to the referral for 
associated persons \18\ who are not the subject of the referral in 
order to reduce the potential financial impact on these parties.
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    \18\ Under the Industry Code, a dispute must be arbitrated if it 
arises out of the business activities of a member or an associated 
person and is between or among members; members and associated 
persons; or associated persons. Rule 13200(a) of the Industry Code.
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    Further, under proposed new Rule 13902(e)(2), FINRA may waive any 
hearing session fees assessed against a member for hearing sessions 
conducted prior to the mid-case referral, if the member is not the 
subject of the referral. The proposed rule would provide FINRA with 
discretion to waive any hearing session fees assessed against a member 
that is named in the arbitration, but is not the subject of the mid-
case referral.
    Finally, under proposed new Rule 13902(e)(3), FINRA would postpone 
any scheduled hearing sessions if a mid-case referral results in the 
withdrawal of the panel, so that a new panel would have flexibility to 
schedule new hearing sessions based on its availability. Thus, if any 
scheduled hearing sessions are postponed, FINRA would waive the 
postponement fees that would otherwise accrue.
Benefits of the Proposed Rule Change
    FINRA believes that the benefits of the proposal outweigh the 
potential burden that a mid-case referral could present to the 
individual investor. For example, if the proposed rule is invoked and 
arbitrators make a mid-case referral, the proposal would mitigate 
somewhat the harm to these investors by waiving the hearing session 
fees for sessions conducted prior to the referral. Moreover, FINRA 
believes that if arbitrators make a mid-case referral and a serious, 
ongoing fraud is exposed, it is likely that either the arbitration 
would cease because of regulatory intervention or the party who is the 
subject of the referral would attempt to settle, rather than risk 
continuing with the case.
    FINRA anticipates that given the rigorous criteria for making a 
referral under the proposed rule change, mid-case referrals will be 
extremely rare. FINRA notes that arbitrators make a relatively small 
number of referrals under the current rule, which permits post-case 
referrals only. However, regardless of the number of mid-case referrals 
that the proposal may generate, FINRA believes that the consequences of 
one widespread fraud, which could prove to be financially devastating 
to many investors, outweigh the potential harm to an individual 
investor whose arbitration is interrupted.
    In addition to the benefits of the proposal, FINRA believes that 
its mission of investor protection and market integrity requires that 
it review continually its rules with the goal of improving their 
effectiveness and relevance. As such, FINRA believes that the Codes 
should not contain a rule that, on its face, requires an arbitrator who 
has reason to believe that there is a serious, ongoing, imminent threat 
to investors to wait until a case is concluded before making a 
referral. In light of the recent well-publicized fraudulent schemes, 
FINRA believes inaction is antithetical to its mission and is, 
therefore, proposing this rule to prevent potential harm to investors 
and the markets. Moreover, FINRA's effectiveness as a regulator would 
be enhanced if it could be alerted earlier to a situation indicating 
the existence of a market manipulation scheme or other ongoing fraud, 
and it could take earlier action.
    FINRA believes the proposal would strengthen its regulation of its 
members and would provide an additional layer of protection to 
investors and the markets from fraudulent securities market schemes.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\19\ which

[[Page 58011]]

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. The proposed rule change is 
consistent with FINRA's statutory obligations under the Act to protect 
investors and the public interest because the proposal would help FINRA 
detect potential market manipulation or fraud at an earlier stage, 
which could minimize the financial losses of investors as well as the 
effects fraudulent schemes could have on the securities markets. Thus, 
the proposed rule change would strengthen FINRA's ability to carry out 
its regulatory mission and provide another layer of protection to 
investors and the markets against fraud.
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    \19\ 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 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. Interested persons are also invited 
to submit written data, views and arguments concerning an arbitration 
panel's withdrawal. 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-2010-036 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-2010-036. 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). Comments are also 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-2010-036 and should be 
submitted on or before October 14, 2010.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-23776 Filed 9-22-10; 8:45 am]
BILLING CODE 8010-01-P