

[Federal Register: December 5, 2007 (Volume 72, Number 233)]
[Notices]               
[Page 68610-68613]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05de07-78]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56855; File No. SR-CBOE-2006-90]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change as Modified by 
Amendment No. 1 Thereto to List and Trade Delayed Start Option Series

November 28, 2007.

I. Introduction

    On November 7, 2006, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange''), 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 proposed rule change to list and trade Delayed Start 
Option SeriesTM (``DSOs'') on any security index that has 
been approved for trading on the Exchange. On September 5, 2007, the 
Exchange filed Amendment No. 1 to the proposed rule change. The 
proposed rule change, as amended, was published for comment in the 
Federal Register on September 17, 2007.\3\ The Commission received no 
comments on the proposal. This order approves the proposed rule change, 
as amended, and designates

[[Page 68611]]

DSOs as ``standardized options'' pursuant to Rule 9b-1 under the 
Act.\4\
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    \1\ 15 U.S.C. 78s(b)(l).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 56378 (September 10, 
2007), 72 FR 52944 (September 17, 2007) (``Notice'').
    \4\ 17 CFR 240.9b-1.
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II. Description of the Proposal

    The Exchange is proposing to introduce for trading a new type of 
security index option product called DSOs. DSOs would possess all of 
the characteristics of existing index options with one variation: at 
the commencement of trading of a particular DSO, and until a 
predetermined date (the ``strike setting date''), there would be no set 
exercise price. Instead, prior to the opening of a particular DSO 
series, a pre-established methodology would be applied to determine the 
strike price of the DSO, and the strike price would then be fixed on 
the strike setting date according to that formula. The Exchange notes 
that DSOs, which address the dependence of an index option's vega 
(volatility exposure) on the relationship between the option's strike 
price and the underlying index level, are designed as a tool to allow 
customers to manage risk associated with the volatility of a particular 
index.\5\
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    \5\ See Notice, supra note 3, at 52945.
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    Product Description. DSOs would be identical to other option series 
that currently trade except that the exercise price for a DSO would be 
fixed based on the closing value of the underlying index on a 
predetermined strike setting date prior to expiration. The particular 
strike setting date would be specified at the time the DSO is initially 
opened for trading and would be no sooner than one month, and no later 
than twelve months, after the series' opening. The particular 
expiration date would also be specified at the time the DSO is 
initially opened for trading and would be no later than what is 
currently permitted under CBOE rules.\6\
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    \6\ Presently, the longest term for an option series expiration 
is thirty-nine months from the listing date. See CBOE Rule 5.8(a) 
and proposed CBOE Rule 24.9(d)(2).
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    Initially, CBOE proposes to establish the strike setting dates for 
all series of DSOs at three months prior to the option's expiration 
date. However, as proposed, CBOE would have the ability to issue series 
of DSOs with more or less time than three months between the strike 
setting date and expiration date. Accordingly, the particular strike 
setting date and the expiration date, and thus the corresponding length 
of the interval between the strike setting date and expiration, would 
be set prior to issuance of each particular series. No changes to any 
terms of an existing DSO series could be made once a series commences 
trading.
    Establishment of Strike Price. On the strike setting date, the DSO 
would be assigned a strike price, which would be at-the-money, in-the-
money, or out-of-the-money, according to the pre-established terms of 
the particular DSO series. A DSO's exercise price would be fixed based 
on the closing value of the underlying index on the strike setting 
date, rounded to the nearest one-eighth (.125) value, or such smaller 
value as the Exchange may designate at the time the DSO is listed, 
provided that the value cannot be smaller than 0.01.\7\ For example, 
using a one-eighth interval, if the S&P 500[supreg] Index (``SPX'') 
closes at 1004.12 on the strike setting date, an at-the-money DSO would 
be assigned a strike price of 1004.125. After the strike setting date, 
the DSO would trade the same as other options until expiration.
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    \7\ Because of system limitations, the Exchange currently plans 
to round DSO exercise prices to the nearest .125. However, should 
the system functionality permit it in the future, the Exchange wants 
the flexibility to be able to determine to round DSO exercise prices 
to a smaller value, provided that the particular increment would be 
designated at the time the DSO is listed and that it would not be 
any smaller than 0.01.
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    An in- or out-of-the money DSO would trade in the exact same manner 
as an at-the-money DSO, except that the strike price would be set to a 
predetermined level either in- or out-of-the-money on the strike 
setting date (e.g., 5% in-the-money, or 5% out-of-the-money). For 
example, if the Exchange determines to list a 5% out-of-the-money DSO 
on the SPX, and the SPX closes at 1000 on the strike setting date, the 
strike price would be established at 1050. The amount by which the 
strike price of an in- or out-of-the money DSO series would be set in- 
or out-of-the-money on the strike setting date would be announced prior 
to the inception of trading of that particular series and could not 
change thereafter.
    Exercise Style. All DSOs would feature European-style exercise 
until the strike setting date (i.e., the option contract could not be 
exercised during this period). After the strike setting date, the DSO 
would be subject to the exercise style (i.e., American or European) of 
the particular index option class. The period during which exercise is 
restricted would therefore depend upon the particular DSO's strike 
setting date, expiration date, and expiration style. For instance, in 
the case of a DSO that is subject to American-style exercise, is issued 
with a nine-month expiration, and has a strike setting date fixed at 
three-months prior to expiration, then the period of non-exercise would 
be six months.\8\
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    \8\ Similarly, a DSO that is subject to European-style exercise 
with a nine-month expiration and a strike setting date fixed at 
three months prior to expiration would have a nine-month period of 
non-exercisability. The strike setting interval would be publicly 
announced prior to the inception of trading of a particular DSO 
series. No changes to any terms of existing DSO series could be made 
once the series trades (with the exception of the establishment of 
the exercise price).
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    Trading Increments, Margin, and Trading Symbols. The Exchange 
proposes to list DSO puts to correspond with each DSO call in a 
particular index option class. As with all other options, the premium 
quotation would be stated in decimals, and one point would equal $100. 
The minimum tick for options trading below $3.00 would be 0.05 ($5.00) 
and for all other series, 0.10 ($10.00).
    DSOs in any particular index option class would be treated the same 
as any other options on the same index for the purpose of determining 
customer margin.\9\ Therefore, a buyer of DSOs would have to pay the 
premium in full, while a seller would have to put up the entire 
premium, plus 15% of the underlying value for a broad-based index 
option, or the premium plus 20% for a narrow-based or micro narrow-
based index option.
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    \9\ See CBOE Rule 12.3. However, the Exchange does not initially 
plan to permit spread margining between DSO and non-DSO options for 
the time period between the initial listing of a DSO and its strike 
setting date. The Exchange intends to consider what spread margin 
would be appropriate and address the subject under a separate rule 
filing.
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    Prior to the strike setting date, margin on any DSO would be based 
on the then-current level of the underlying index. For example, a DSO 
whose strike price would be set at-the-money would be margined as an 
at-the-money option in the same index option class prior to the strike 
setting date, because prior to the strike setting date the DSO's price 
would be directly related to the price of an at-the-money option. Prior 
to the strike setting date, in- and out-of-the-money DSOs would be 
margined the same as any other in- and out-of-the-money options in the 
same index option class.
    Prior to the strike setting date, DSOs would be distinguished from 
existing options by a unique root symbol and a special strike price 
code designating an at-the-money, in-the-money, or out-of-the-money 
option. The Exchange intends to trade the DSO series under separate 
symbols from other option series on the same index option class. The 
exact exercise price, and a unique DSO strike price code, would be 
fixed on the strike setting date pursuant to the method established at 
the time the

[[Page 68612]]

option series was originally opened for trading. The strike price code 
would specify the exact strike price of the particular DSO option 
series (rounded to the nearest eighth or smaller increment, if 
applicable).
    Position and Exercise Limits. Positions in any DSO would be subject 
to the same rules governing position and exercise limits upon other 
options in the same index option class and, for purposes of determining 
position limits, DSO positions would be aggregated with positions in 
other series of the same option class.\10\ Similarly, members and 
member organizations trading in DSOs would continue to be subject to 
the same reporting requirements and margin and clearing firm 
requirements as provided under Interpretations and Policies .03 and .04 
to CBOE Rule 24.4.
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    \10\ See CBOE Rules 4.11, 4.12, 24.4, 24.4A, and 24.4B. In 
addition, the Exchange is proposing to clarify in Rule 24.4B 
(Position Limits for Options on Micro Narrow-Based Indexes as 
Defined Under Rule 24.2(d)) that position in Short Term Option 
Series and Quarterly Options, together with DSO positions, shall be 
aggregated with positions in options contracts in the same class.
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    Pricing of a DSO. Similar to other index options, the pricing of an 
at-the-money DSO, for example, would reflect the price of the 
underlying index, implied volatility, interest rates, time to 
expiration, and strike price. Therefore, the price for a DSO would 
generally approximate the concurrent price for a similar option, with 
one significant deviation: whereas other options are priced based on 
current levels of implied volatility, a DSO is priced using an 
expectation of implied volatility levels at the time the strike price 
is set, which is generally derived from the current level of implied 
volatility. The dependence of a particular DSO's price on expected 
implied volatility is what the Exchange believes would make DSOs useful 
to market participants that are interested in volatility trading.
    Customer Suitability. Although the Exchange believes that DSOs may 
be suitable for all types of investors, the Exchange has proposed to 
limit the trading of DSOs to investors with prior options trading 
experience.\11\ Also, prior to the commencement of trading of DSOs, the 
Exchange would make available on its Web site all information necessary 
to inform members and customers of the addition of new DSO series to a 
particular option class.
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    \11\ See Notice, supra note 3, at 52947. See also Proposed CBOE 
Rule 9.9, Interpretations and Policies .01.
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    Surveillance. The Exchange represents that it has in place 
appropriate surveillance procedures to monitor trading activity in DSOs 
and intends to monitor trading activity in DSOs like any other option 
series listed in that same index option class.\12\
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    \12\ See Notice, supra note 3, at 52948.
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III. Discussion and Commission Findings

    The Commission has carefully reviewed the proposed rule change and 
finds that it is consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange.\13\ In particular, the Commission finds that the proposed 
rule change is consistent with section 6(b)(5) of the Act,\14\ which, 
among other things, requires that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
regulating 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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    \13\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \14\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that options similar to CBOE's proposed DSOs 
currently trade in the over-the-counter market. The introduction of 
CBOE's proposed DSOs will provide investors with an exchange-traded 
product to manage the risk associated with changes in volatility of a 
particular security index, thereby providing additional investment 
options to investors in the context of a transparent exchange-traded 
market for these products.
    In addition, DSOs will be subject to CBOE's rules applicable to 
other standardized options. For example, positions in a DSO will be 
subject to CBOE's rules governing position and exercise limits and, for 
the purposes of determining position limits, DSO positions will be 
aggregated with positions in other series of the same option class. 
Similarly, CBOE members and member organizations trading in DSOs will 
be subject to the reporting requirements and clearing firm requirements 
provided under CBOE rules. Further, DSOs in any particular index option 
class will be treated the same as any other options on the same index 
for the purpose of determining customer margin.
    The Commission notes that the Exchange has represented that it has 
surveillance procedures in place that are adequate to monitor trading 
in DSOs. In particular, the Exchange will monitor trading activity in 
DSOs as it does for other option series listed in the same index option 
class. Further, the Exchange will limit trading of DSOs to investors 
with prior options trading experience, and will provide information 
about DSOs on its Web site, including information that describes the 
terms and operation of DSOs.
    Accordingly, the Commission finds that the proposed rule change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder, and should promote just and equitable 
principles of trade while protecting investors and the public interest.

IV. Designation of DSOs as Standardized Options Pursuant to Rule 19b-1

    Rule 9b-1 under the Act establishes a disclosure framework for 
standardized options that are traded on a national securities exchange 
and cleared through a registered clearing agency.\15\ Under this 
framework, the exchange on which a standardized option is listed and 
traded must prepare an Options Disclosure Document (``ODD'') that, 
among other things, identifies the issuer and describes the uses, 
mechanics, and risks of options trading, in language that can be easily 
understood by the general investing public. The ODD is treated as a 
substitute for the traditional prospectus. A broker-dealer must provide 
a copy of the ODD to each customer at or before approving the 
customer's account for trading any standardized option.\16\ Any 
amendment to the ODD must be distributed to each customer whose account 
is approved for trading the options class for which the ODD 
relates.\17\
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    \15\ ``Standardized options'' are defined in Rule 9b-1(a)(4) as 
``options contracts trading on a national securities exchange, an 
automated quotation system of a registered securities association, 
or a foreign securities exchange which relate to options classes the 
terms of which are limited to specific expiration dates and exercise 
prices, or such other securities as the Commission may, by order, 
designate.'' 17 CFR 240.9b-1(a)(4).
    \16\ See 17 CFR 240.9b-1(d)(1).
    \17\ See 17 CFR 240.9b-1(d)(2).
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    Pursuant to Rule 9b-1 under the Act, use of the ODD is limited to 
``standardized options'' for which there is an effective registration 
statement on Form S-20 under the Securities Act of 1933 (``Securities 
Act'') or that are otherwise exempt from registration.\18\

[[Page 68613]]

Pursuant to Rule 9b-1(a)(4), the Commission may, by order, designate as 
``standardized options'' securities that do not otherwise meet the 
definition of ``standardized options'' but which ``the Commission 
believes should be included within the [options] disclosure 
framework.'' \19\ The Commission has used this authority in the past, 
for example, in connection with the listing and trading of Index 
Participations,\20\ FLEX options,\21\ credit default options,\22\ and 
credit default basket options.\23\ CBOE has requested that the 
Commission designate DSOs as standardized options so that the ODD may 
be used for DSOs.\24\
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    \18\ See 17 CFR 240.9b-1(b)(1) and (c)(8). See also 17 CFR 
230.238 (``Rule 238''). Rule 238 under the Securities Act provides 
an exemption from the Securities Act for any standardized option, as 
defined by Rule 9b-1(a)(4) under the Act, with limited exceptions. 
Rule 238 does not exempt standardized options from the anti-fraud 
provisions of Section 17 of the Securities Act, 15 U.S.C. 77q. Also, 
offers and sales of standardized options by or on behalf of the 
issuer of the underlying security or securities, an affiliate of the 
issuer, or an underwriter, will constitute an offer or sale of the 
underlying security or securities as defined in Section 2(a)(3) of 
the Securities Act, 15 U.S.C. 77b(a)(3). See also Securities Act 
Release No. 8171 (December 23, 2002), 68 FR 188 (January 2, 2003) 
(Exemption for Standardized Options From Provisions of the 
Securities Act of 1933 and From Registration Requirements of the 
Exchange Act of 1934).
    \19\ See Securities Exchange Act Release No. 19055 (September 
16, 1982), 47 FR 41950, 41954 (September 23, 1982).
    \20\ See Securities Exchange Act Release No. 26709 (April 11, 
1989), 54 FR 15280 (April 17, 1989) (SR-Phlx-88-07; SR-Amex-88-10; 
SR-CBOE-88-09).
    \21\ See Securities Exchange Act Nos. 31910 (February 23, 1993), 
58 FR 12056 (March 2, 1993) (SR-CBOE-92-17; SR-OCC-92-33; ODD 93-1) 
(order designating FLEX index options as standardized options under 
Rule 9b-1); and 36841 (February 14, 1996), 61 FR 6666 (February 21, 
1996) (SR-CBOE-95-43 and SR-PSE-95-24) and 37336 (June 19, 1996), 61 
FR 33558 (June 27, 1996) (SR-Amex-95-57) (orders approving the 
listing and trading of FLEX equity options, and designating them as 
standardized options pursuant to Rule 9b-1 under the Act).
    \22\ See Securities Exchange Act Release No. 55871 (June 6, 
2007), 72 FR 32372 (June 12, 2007) (SR-CBOE-2006-84).
    \23\ See Securities Exchange Act Release No. 56275 (August 17, 
2007), 72 FR 47097 (August 22, 2007) (SR-CBOE-2007-26).
    \24\ See Notice, supra note 3, at 52947.
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    The Commission hereby designates DSOs, as separately defined in the 
Options Clearing Corporation's (``OCC'') proposal,\25\ as standardized 
options for purposes of Rule 9b-1 under the Act. DSOs do not meet the 
definition of standardized options because they do not have a specific 
exercise price. Whereas the exercise price of a conventional 
standardized option is determined when the option series is first 
listed for trading, the exercise price for a DSO would not be 
determined until the strike setting date. Instead, prior to the listing 
of the particular DSO series, the Exchange will specify a formula to 
determine the strike price of the DSO on the pre-determined strike 
setting date according to the terms of the formula.\26\ No changes to 
any terms of existing DSO series could be made once the series begins 
trading.
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    \25\ The OCC has filed with the Commission a proposed rule 
change to enable it to clear and settle DSOs proposed to be listed 
by CBOE (the ``OCC Proposal''). See Securities Exchange Act Release 
No. 56856 (November 28, 2007) (SR-OCC-2007-13) (order noticing and 
granting accelerated approval). The OCC Proposal defines the term 
``delayed start option'' to mean ``an option that at the 
commencement of trading does not have an exercise price but instead 
has an exercise price setting formula pursuant to which the exercise 
price will be fixed on the exercise price setting date for the 
series of delayed start option.'' This definition of DSOs is being 
added to Article 1, Section 1 of the OCC's By-Laws.
    \26\ Prior to the opening of the particular DSO series, the 
Exchange will announce the strike setting date as well as the 
expiration date of the DSO.
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    Aside from the determination of the exercise price, DSOs resemble 
standardized options in other significant respects. DSOs have an 
underlying security index and a specific expiration date. Like other 
standardized options, they also have standardized terms pertaining to 
the rights and obligations of holders and writers. The fact that DSOs 
lack a specified exercise price at the commencement of trading does not 
detract from their character as options. Compared with FLEX options, 
which the Commission has also declared to be ``standardized options,'' 
\27\ the terms of DSOs would be even more standardized in that a strike 
price formula, settlement, expiration date, and exercise style would be 
fixed by the Exchange for each DSO series. In addition, similar to 
DSOs, credit default options and credit default basket options, which 
were recently designated by the Commission as ``standardized options,'' 
also have many characteristics of standardized options, except for 
exercise price.\28\
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    \27\ See supra note 21 (citing the applicable orders regarding 
FLEX equity and index options).
    \28\ See supra notes 22 and 23 (citing the approval orders for 
credit default options and credit default basket options, 
respectively).
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    The Commission also believes that the fact that the OCC, the 
clearing agency for standardized options, is willing to serve as issuer 
of DSOs supports the view that adding DSOs to the standardized option 
disclosure framework is reasonable.\29\
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    \29\ The Commission notes that CBOE presently intends to offer 
DSOs in early 2008, and has represented that they will not introduce 
DSOs before the supplement to the ODD has been submitted to the 
Commission pursuant to Rule 9b-1 under the Act. Telephone 
conversation between Richard Holley III, Senior Special Counsel, 
Division of Trading and Markets, Commission, and Jennifer M. Lamie, 
Assistant General Counsel, CBOE, on November 16, 2007.
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    Therefore, the Commission herein designates DSOs, such as those 
proposed by CBOE, as standardized options for purposes of Rule 9b-1 
under the Act.\30\
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    \30\ 17 CFR 240.9b-1.
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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-CBOE-2006-90) as modified by 
Amendment No. 1 thereto, be, and hereby is, approved.
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    \31\ 15 U.S.C. 78s(b)(2).
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    It is further ordered, pursuant to Rule 9b-1(a)(4) under the 
Act,\32\ that DSOs, as defined in proposed rule change SR-OCC-2007-13, 
are hereby designated as standardized options.
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    \32\ 17 CFR 240.9b-1(a)(4).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\33\
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    \33\ 17 CFR 200.30-3(a)(12) and 17 CFR 200.30-3(a)(51).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-23533 Filed 12-4-07; 8:45 am]

BILLING CODE 8011-01-P
