Document ID: SEC-2008-0434-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2008-03-20T04:00Z

[Federal Register: March 20, 2008 (Volume 73, Number 55)]
[Notices]               
[Page 15025-15028]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr20mr08-74]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57492; File No. SR-NASD-2007-021]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc. (n/k/a Financial Industry Regulatory Authority, Inc.); 
Order Approving Proposed Rule Change To Amend the Definition of Public 
Arbitrator

March 13, 2008.
    On March 12, 2007, the National Association of Securities Dealers, 
Inc. (``NASD''), through its wholly owned subsidiary, NASD Dispute 
Resolution, Inc. (n/k/a FINRA Dispute Resolution, Inc.) filed with the 
Securities and Exchange Commission (``Commission'') pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (the ``Act''),\1\ and 
Rule 19b-4 thereunder,\2\ a proposed rule change to amend the 
definition of ``public arbitrator'' in the NASD's Code of Arbitration 
Procedure for Customer Disputes (``Customer Code'') and Code of 
Arbitration Procedure for Industry Disputes (``Industry Code'').\3\ The 
proposed rule change was published for comment in the Federal Register 
on July 17,

[[Page 15026]]

2007.\4\ The Commission received 62 comments on the proposed rule 
change \5\ and FINRA's response to the comments.\6\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On July 26, 2007, the Commission approved a proposed rule 
change filed by NASD to amend NASD's Certificate of Incorporation to 
reflect its name change to Financial Industry Regulatory Authority 
Inc., or FINRA, in connection with the consolidation of the member 
firm regulatory functions of NASD and NYSE Regulation, Inc. See 
Securities Exchange Act Release No. 56146 (July 26, 2007). In 
connection with this name change, NASD Dispute Resolution became 
FINRA Dispute Resolution, Inc. (``FINRA Dispute Resolution'').
    \4\ See Securities Exchange Act Release No. 56039 (July 10, 
2007), 72 FR 39110 (July 17, 2007).
    \5\ Comment letters were submitted by Philip M. Aidikoff, Esq., 
Attorney, dated July 17, 2007 (``Aidikoff Letter''); Professor Seth 
E. Lipner, Zicklin School of Business, Baruch College, dated July 
23, 2007 (``Lipner Letter''); Steven B. Caruso, Esq., President, 
Public Investors Arbitration Bar Association, dated July 23, 2007 
(``PIABA Letter''), William S. Shepherd, Esq., Founder, Shepherd, 
Smith & Edwards, LLP, dated July 24, 2007 (``Shepherd Letter''); 
Richard Layne, dated July 25, 2007 (``Layne Letter''); Dale 
Ledbetter, Ledbetter Associates, dated July 25, 2007 (``Ledbetter 
Letter''); Jeffrey B. Kaplan, Esq., Dimond Kaplan Rothstein, P.A., 
dated July 25, 2007 (``Kaplan Letter''); Charles C. Mihalek, Esq., 
dated July 25, 2007 (``Mihalek Letter''); Daniel A. Ball, Esq., Ball 
Law Offices, dated July 25, 2007 (``Ball Letter''); Stuart D. 
Meissner, Esq., Law Offices of Stuart D. Meissner LLC, dated July 
25, 2007 (``Meissner Letter''); Adam S. Doner, Esq., dated July 25, 
2007 (``Doner Letter''); Jay H. Salamon, Esq., Hermann Cahn & 
Schneider LLP, dated July 25, 2007 (``Salamon Letter''); Robert W. 
Goehring, Esq., dated July 25, 2007 (``Goehring Letter''); Barry D. 
Estell, dated July 25, 2007 (``Estell Letter''); Steve A. 
Buchwalter, Esq., Law Offices of Steve A. Buchwalter, P.C., dated 
July 25, 2007 (``Buchwalter Letter''); Charles W. Austin, Jr., dated 
July 25, 2007 (``Austin Letter''); Les Greenberg, Esq., Law Offices 
of Les Greenberg, dated July 27, 2007 (``Greenberg Letter''); 
Jeffrey A. Feldman, Esq., Law Offices of Jeffrey A. Feldman, dated 
July 27, 2007 (``Feldman Letter''); Frederick W. Rosenberg, Esq., 
dated July 30, 2007 (``Rosenberg Letter''); W. Scott Greco, Esq., 
Greco & Greco, P.C., dated July 31, 2007 (``Greco Letter''); Bryan 
J. Lantagne, Esq., Director, Massachusetts Securities Division and 
Chair, NASAA Arbitration Working Group, dated August 2, 2007 
(``NASAA Letter''); Peter J. Mougey, Esq., Beggs & Lane, dated 
August 3, 2007 (``Mougey Letter''); Andrew Stoltmann, Esq., Stoltman 
Law Offices, P.C., dated August 6, 2007 (``Stoltman Letter''); 
Robert C. Port, Esq., Cohen Goldstein Port & Gottlieb, LLP, dated 
August 6, 2007 (``Port Letter''); James D. Keeney, Esq., James D. 
Keeney, P.A., dated August 6, 2007 (``Keeney Letter''); Herb Pounds, 
Esq., Herbert E. Pounds, Jr., P.C., dated August 6, 2007 (``Pounds 
Letter''); John Miller, Esq., Swanson Midgley LLC, dated August 6, 
2007 (``Miller Letter''); Janet K. DeCosta, Esq., dated August 6, 
2007 (``DeCosta Letter''); Milton H. Fried, Jr., Esq., dated August 
6, 2007 (``Fried Letter''); Laurence S. Schultz, Esq., Driggers, 
Schultz & Herbst, dated August 6, 2007 (``Schultz Letter''); Mark A. 
Tepper, Esq., President, Mark A. Tepper, P.A., dated August 6, 2007 
(``Tepper Letter''); Leonard Steiner, dated August 6, 2007 
(``Steiner Letter''); William P. Torngren, Esq., dated August 6, 
2007 (``Torngren Letter''); Richard A. Lewins, Esq., Special 
Counsel, Burg Simpson Eldredge Hersh & Jardine P.C., dated August 7, 
2007 (``Lewins Letter''); Jonathan W. Evans, Esq., Jonathan W. Evans 
& Associates, dated August 7, 2007 (``Evans Letter''); Kathleen H. 
Gorr, Esq., dated August 7, 2007 (``Gorr Letter''); Martin L. 
Feinberg, Esq., dated August 8, 2007 (``Feinberg Letter''); Dave 
Liebrader, Esq., dated August 8, 2007 (``Liebrader Letter''); Steven 
M. McCauley, Esq., dated August 8, 2007 (``McCauley Letter''); David 
Harrison, dated August 8, 2007 (``Harrison Letter''); Rob Bleecher, 
Esq., dated August 8, 2007 (``Bleecher Letter''); Thomas C. Wagner, 
Esq., Van Deusen & Wagner L.L.C., dated August 8, 2007 (``Wagner 
Letter''); Carl J. Carlson, Esq., Carlson & Dennett, P.S., dated 
August 8, 2007 (``Carlson Letter''); Robert S. Banks, Jr., Esq., The 
Banks Law Office, P.C., dated August 8, 2007 (``Banks Letter''); 
Jeffrey S. Kruske, Esq., Law Office of Jeffrey S. Kruske, P.A., 
dated August 8, 2007 (``Kruske Letter''); Mitchell S. Ostwald, Esq., 
The Law Offices of Mitchell S. Ostwald, dated August 8, 2007 
(``Ostwald Letter''); Debra G. Speyer, Esq., Law Offices of Debra G. 
Speyer, dated August 8, 2007 (``Speyer Letter''); Dawn R. Meade, 
Esq., The Spencer Law Firm, dated August 9, 2007 (``Meade Letter''); 
Scott C. Ilgenfritz, Esq., dated August 8, 2007 (``Ilgenfritz 
Letter''); Eliot Goldstein, Esq., Partner, Law Offices of Eliot 
Goldstein, LLP, dated August 9, 2007 (``Goldstein Letter''); Howard 
Rosenfield, Esq., Law Offices of Howard Rosenfield, dated August 10, 
2007 (``Rosenfield Letter''); Scott R. Shewan, Esq., Born, Pape & 
Shewan LLP, dated August 13, 2007 (``Shewan Letter''); Joseph Fogel, 
Esq., Fogel & Associates, dated August 14, 2007 (``Fogel Letter''); 
Donald M. Feferman, Esq., Donald M. Feferman, P.C., dated August 16, 
2007 (``Feferman Letter''); Gail E. Boliver, Esq., Boliver Law Firm, 
dated August 19, 2007 (``Boliver Letter''); Stephen P. Meyer, Esq., 
Meyer & Ford, dated August 20, 2007 (``Meyer Letter''); Jan Graham, 
Esq., Graham Law Offices, dated August 20, 2007 (``Graham Letter''); 
John E. Sutherland, Esq., dated August 20, 2007 (``Sutherland 
Letter''); Ronald M. Amato, Esq., Shaheen, Novoselsky, Staat, 
Filipowski & Eccleston, P.C, dated August 21, 2007 (``Amato 
Letter''); James J. Eccleston, Esq., Shaheen, Novoselsky, Staat, 
Filipowski & Eccleston, P.C, dated August 21, 2007 (``Eccleston 
Letter''); J. L. Spray, Esq., Mattson, Ricketts, Davies, Stewart & 
Calkins, dated August 21, 2007 (``Spray Letter''); Randall R. 
Heiner, Esq., Heiner Law Offices, dated August 23, 2007 (``Heiner 
Letter'').
    The public file for the proposal, which includes comment letters 
received on the proposal, is located at the Commission's Public 
Reference Room located at 100 F Street, NE., Washington, DC 20549. 
The comment letters are also available on the Commission's Internet 
Web site (http://www.sec.gov/rules/sro.shtml).
    \6\ See Letter from Mignon McLemore, Assistant Chief Counsel, 
FINRA Dispute Resolution, to Nancy M. Morris, Secretary, Commission, 
dated January 17, 2008 (``FINRA Response'').
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I. Description of the Proposed Rule Change

    FINRA Dispute Resolution, Inc. proposes to amend the Customer Code 
and the Industry Code to amend the definition of public arbitrator to 
add an annual revenue limitation. In discussing the proposed rule 
change, FINRA stated that it and its predecessor NASD had taken 
numerous steps in recent years to ensure the integrity and neutrality 
of the forum's arbitrator roster by addressing classification of 
arbitrators. For example, in August 2003, NASD proposed changes to 
Rules 10308 and 10312 of the Code of Arbitration Procedure (``Code'') 
to modify the definitions of public and non-public arbitrators to 
further prevent individuals with significant ties to the securities 
industry from serving as public arbitrators.\7\ The 2003 proposal:
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    \7\ In July 2002, the Commission retained Professor Michael 
Perino to assess the adequacy of arbitrator disclosure requirements 
at the NASD and at the New York Stock Exchange (``NYSE''). Professor 
Perino's report (``Perino Report'') concluded that undisclosed 
conflicts of interest were not a significant problem in arbitrations 
sponsored by self-regulatory organizations (``SROs''), such as NASD 
and the NYSE. However, the Perino Report recommended several 
amendments to SRO arbitrator classification and disclosure rules 
that might ''provide additional assurance to investors that 
arbitrations are in fact neutral and fair.'' This proposal 
implemented the recommendations of the Perino Report and made 
several other related changes to the definitions of public and non-
public arbitrators that were consistent with the Perino Report 
recommendations. The Perino Report is available at http://
www.sec.gov/pdf/arbconflict.pdf.
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     Increased from three years to five years the period for 
transitioning from a non-public to public arbitrator after leaving the 
securities industry.
     Clarified that the term ``retired'' from the industry 
includes anyone who spent a substantial part of his or her career in 
the industry.
     Prohibited anyone who has been associated with the 
industry for at least 20 years from ever becoming a public arbitrator, 
regardless of how long ago the association ended.
     Excluded from the public arbitrator roster attorneys, 
accountants, or other professionals whose firms have derived 10 percent 
or more of their annual revenue in the previous two years from clients 
involved in securities-related activities.
The proposal was approved by the Commission on April 16, 2004, and 
became effective on July 19, 2004.\8\
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    \8\ See Securities Exchange Act Release No. 49573 (April 16, 
2004), 69 FR 21871 (April 22, 2004) (SR-NASD-2003-95) (approval 
order). The changes were announced in Notice to Members 04-49 (June 
2004).
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    On July 22, 2005, NASD proposed further amendments to Rule 10308 of 
the Code relating to arbitrator classification to prevent individuals 
with certain indirect ties to the securities industry from serving as 
public arbitrators. Specifically, NASD proposed to amend the definition 
of public arbitrator to exclude individuals who work for, or are 
officers or directors of, an entity that controls, is controlled by, or 
is under common control with, a broker-dealer, or who have a spouse or 
immediate family member who works for, or is an officer or director of, 
an entity that is in such a control relationship with a broker-dealer. 
NASD also proposed to amend Rule 10308 to clarify that individuals 
registered through broker-dealers may not be public arbitrators, even 
if they are also employed by a non-broker-dealer (such as a bank). This 
rule filing was approved by the Commission on October 16, 2006, and 
became effective on January 15, 2007.\9\
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    \9\ See Securities Exchange Act Release No. 54607 (October 16, 
2006), 71 FR 62026 (Oct. 20, 2006) (SR-NASD-2005-094) (approval 
order). The changes were announced in Notice to Members 06-64 
(November 2006).
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    During the time that the changes discussed above were being made, 
NASD also had pending at the Commission a 2003 proposal to amend the 
Code to reorganize the rules into the

[[Page 15027]]

Customer Code, the Industry Code, and a separate code for mediation. 
The final provisions of this proposal were approved by the Commission 
on January 24, 2007, and became effective on April 16, 2007.\10\ 
Several substantive changes to the Customer and Industry Codes affected 
the classification of arbitrators \11\ and how they are selected for 
panels.\12\
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    \10\ See Securities Exchange Act Release No. 51856 (June 15, 
2005), 70 FR 36442 (June 23, 2005) (SR-NASD-2003-158) (notice); 
Securities Exchange Act Release No. 51857 (June 15, 2005), 70 FR 
36430 (June 23, 2005) (SR-NASD-2004-011) (notice); and Securities 
Exchange Act Release No. 51855 (June 15, 2005), 70 FR 36440 (June 
23, 2005) (SR-NASD-2004-013) (notice). The changes were announced in 
Notice to Members 07-07 (February 2007).
    \11\ FINRA believes the new codes have improved the arbitrator 
selection process by creating and maintaining a new roster of 
arbitrators who are qualified to serve as chairpersons. The chair 
roster consists of more experienced arbitrators available on FINRA's 
public arbitrator roster for all investor cases and for certain 
intra-industry cases. For other industry cases, the Customer Code 
and Industry Code also create a chair roster of experienced non-
public arbitrators. See Rules 12400(b) and (c) of the Customer Code 
and Rules 13400(b) and (c) of the Industry Code.
    \12\ The Customer Code and Industry Code also change how 
arbitrator lists are generated and how arbitrators are selected for 
a panel. See Rules 12403 and 12404 of the Customer Code and Rules 
13403 and 13404 of the Industry Code.
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    Despite these changes to the arbitrator classification rules, some 
users of the forum continued to voice concerns about individuals 
serving as public arbitrators when they have business relationships 
with entities that derive income from broker-dealers. For example, an 
arbitrator classified as public might work for a very large law firm 
that derives less than 10% of its annual revenue from broker-dealer 
clients, but still receives a large dollar amount of such revenue. 
Concern focuses primarily on a law firm's defense of action (in 
arbitration or litigation) by customers of broker-dealers, and not on 
its representation of broker-dealers in underwriting or other 
activities. Some recommended that there be an annual dollar limitation 
of $50,000 on revenue from broker-dealers relating to customer disputes 
with a brokerage firm or associated person concerning an investment 
account.
    In response to these recommendations, FINRA proposed to amend the 
definition of public arbitrator in Rule 12100(u) of the Customer Code 
and Rule 13100(u) of the Industry Code to add a provision that would 
prevent an attorney, accountant, or other professional from being 
classified as a public arbitrator, if the person's firm derived $50,000 
or more in annual revenue in the past two years from professional 
services rendered to any persons or entities listed in Rule 12100(p)(1) 
of the Customer Code or Rule 13100(p)(1) of the Industry Code relating 
to any customer disputes concerning an investment account or 
transaction, including but not limited to, law firm fees, accounting 
firm fees, and consulting fees.\13\
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    \13\ Rule 12100(p) defines ``non-public arbitrator.'' Paragraph 
(1) of the rule states, in relevant part, that the term ``non-public 
arbitrator'' means a person who is otherwise qualified to serve as 
an arbitrator and is or, within the past five years, was: (A) 
associated with, including registered through, a broker or a dealer 
(including a government securities broker or dealer or a municipal 
securities dealer); (B) registered under the Commodity Exchange Act; 
(C) a member of a commodities exchange or a registered futures 
association; or (D) associated with a person or firm registered 
under the Commodity Exchange Act. Rule 13100(p) is the same as Rule 
12100(p).
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    FINRA stated that the proposed amendment, in conjunction with the 
existing 10 percent revenue limitation,\14\ would further improve its 
public arbitrator roster by ensuring that arbitrators whose firms 
receive a significant amount of compensation from any persons or 
entities associated with or engaged in the securities, commodities, or 
futures business are removed from the public roster.\15\
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    \14\ See supra note 4. Under the July 2004 amendments, a public 
arbitrator cannot be ``an attorney, accountant, or other 
professional whose firm derived 10 percent or more of its annual 
revenue in the past 2 years from any persons or entities listed in 
Rules 12100(p)(1) and 13100(p)(1) of the new Codes.''
    \15\ FINRA will survey its public arbitrators to determine which 
arbitrators will be removed from the roster for appointment to new 
cases upon the effective date of the proposed rule.
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II. Summary of Comments and FINRA's Response

    The Commission received 62 comment letters.\16\ Many of the 
commenters raised common issues and shared the same views on these 
issues, regardless of whether they supported or opposed the proposal 
overall. In particular, a majority of the commenters argued that 
arbitrators should not be classified as public arbitrators under the 
rule if they are attorneys, accountants or other professionals whose 
firms receive any compensation or revenue from the securities 
industry.\17\ FINRA responded that the proposed $50,000 annual revenue 
limitation would reasonably narrow the definition of public arbitrator, 
removing from the public arbitrator pool those arbitrators whose firms 
derive substantial revenue from providing professional services to 
members of the securities industry involving customer disputes, while 
simultaneously maintaining the integrity of the public arbitrator 
roster.\18\
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    \16\ See supra, note 5.
    \17\ See Speyer, Goehring, Doner, Ledbetter, Aidikoff, Meissner, 
Boliver, Meyer, Lewins, Harrison, McCauley, Torngren, Ball, 
Feinberg, Tepper, Sutherland, Fogel, Bleecher, Steiner, Miller, 
Mihalek, Kaplan, Lipner, Shepherd, Layne, Salamon, Buchwalter, 
Feldman, Shewan, and Mougey Letters.
    \18\ See FINRA Response.
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    Many commenters also argued that the proposed $50,000 annual 
revenue limitation should not be limited to professional services 
related to customer disputes concerning an investment account or 
transaction and instead should include all professional services 
rendered by the arbitrator's firm to a firm or associated person.\19\ 
FINRA responded that the annual revenue limitation should be restricted 
to the provision of those services, such as defense work in a customer 
dispute, that are closely related to matters that arbitrators would be 
deciding in an arbitration proceeding and, therefore, might affect the 
arbitrator's impartiality.\20\ Moreover, FINRA stated that expanding 
the proposed annual revenue limitation to include all services could 
result in the removal of experienced, competent public arbitrators from 
their roster.\21\
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    \19\ See NASAA, PIABA, Meade, Ilgenfritz, Liebrader, Gorr, 
Pounds, Keeney, Fried, Estell, Heiner, DeCosta, Schultz, Evans, 
Wagner, Ostwald, Kruske, Carlson, Port, Stotman, Graham, Feferman, 
and Rosenfield Letters.
    \20\ See FINRA Response.
    \21\ See id.
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    Several commenters expressed doubt regarding FINRA's ability to 
monitor and enforce the $50,000 annual revenue limitation.\22\ FINRA 
responded that because arbitrators must continually update their 
disclosure reports and, when selected to serve on a case, must complete 
a checklist and take an oath confirming that the arbitrator's 
disclosures are true and complete, the procedures are sufficient.\23\
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    \22\ See PIABA, Speyer, Liebrader, Heiner, Goldtein, Schultz, 
Evans, Wagner, Ostwald, Feinberg, Tepper, Graham, Feferman, and 
Feldman Letters.
    \23\ See FINRA Response.
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    One commenter suggested that a ``cooling off'' period be 
implemented after the annual revenue limitation no longer applies and 
before a person can serve as a public arbitrator.\24\ The commenter 
noted that this concept is applied to individuals who have been out of 
the securities industry for fewer than five years by assigning them to 
the non-public arbitrator pool.\25\ FINRA responded that there is a 
distinction between individuals who work in the securities industry and 
individuals whose firms receive revenue for providing services to 
members of the

[[Page 15028]]

industry.\26\ In the case of individuals who worked in the industry, 
FINRA indicated that a five-year ``cooling off'' period is appropriate, 
as such individuals might maintain close relationships with staff at 
their former firms.\27\ FINRA stated that the potential for such bias 
is less likely to exist for individuals whose firms receive a de 
minimis amount of annual revenue for providing services to members of 
the securities industry and, therefore, that a similar ``cooling off'' 
period should not be required.\28\
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    \24\ See Feinberg Letter.
    \25\ See id.
    \26\ See FINRA Response.
    \27\ See id. (citing Rule 12100(p)(1) of the Customer Code and 
Rule 13100(p)(1) of the Industry Code).
    \28\ See id.
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    Finally, numerous commenters argued that the requirement that a 
non-public arbitrator be a member of a three-person panel involving a 
customer dispute should be eliminated.\29\ FINRA indicated that these 
comments are outside the scope of the rule filing because it is not 
amending the provisions of the Codes that address this issue.
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    \29\ See NASAA, Pounds, Fried, Estell, Goldstein, Banks, 
Harrison, McCauley, Torngren, Feinberg, Sutherland, Spray and 
Salamon Letters.
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III. Discussion

    After careful review, and consideration of commenters' views and 
the FINRA Response, 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.\30\ In particular, the Commission finds that the proposed 
rule change is consistent with the provisions of Section 15A(b)(6) of 
the Act, which requires, among other things, that rules of a national 
securities association 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 Commission believes that the proposed rule change 
meets this standard by removing from the pool of public arbitrators 
those individuals whose firms receive a significant amount of 
compensation for service on matters closely related to those that 
arbitrators consider during arbitration proceedings.
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    \30\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\31\ that the proposed rule change (SR-NASD-2007-021) be, and 
hereby is, approved.
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    \31\ 15 U.S.C. 78s(b)(2).
    \32\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-5572 Filed 3-19-08; 8:45 am]

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