
[Federal Register Volume 79, Number 18 (Tuesday, January 28, 2014)]
[Notices]
[Pages 4512-4515]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-01510]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71365; File No. SR-ISE-2013-42]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Order Granting Approval of Proposed Rule Change, as Modified by 
Amendment No. 1, To List Options on the Nations VolDex Index

I. Introduction

    On July 17, 2013, the International Securities Exchange, LLC 
(``Exchange'' or ``ISE'') 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 options on the Nations 
VolDex Index (``Index''). The proposed rule change was published for 
comment in the Federal Register on August 2, 2013.\3\ The Commission 
received one comment letter on the proposed rule change.\4\ On 
September 10, 2013, the Commission extended the time period for 
Commission action to October 31, 2013.\5\ On October 29, 2013, ISE 
submitted a response to the comment letter.\6\ On October 30, 2013, ISE 
submitted Amendment No. 1 to the proposed rule change. On October 31, 
2013, the Commission instituted proceedings to determine whether to 
approve or disapprove the proposed rule change, as modified by 
Amendment No. 1.\7\ The Commission subsequently received one additional 
comment letter on the proposed rule change.\8\ This order grants 
approval of the proposed rule change, 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\ See Securities Exchange Act Release No. 70059 (July 29, 
2013), 78 FR 47041 (``Notice'').
    \4\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from Edward T. Tilly, Chief Executive Officer, Chicago Board Options 
Exchange, Incorporated (``CBOE''), dated August 23, 2013 (``CBOE 
Letter I'').
    \5\ See Securities Exchange Act Release No. 70362, 78 FR 56955 
(September 16, 2013).
    \6\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from Michael J. Simon, Secretary and General Counsel, ISE, dated 
October 29, 2013 (``ISE Letter'').
    \7\ See Securities Exchange Act Release No. 70787, 78 FR 66798 
(November 6, 2013).
    \8\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from Edward T. Tilly, Chief Executive Officer, CBOE, dated November 
27, 2013 (``CBOE Letter II'').
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II. Description of the Proposed Rule Change

    The Exchange proposes to list and trade cash-settled, European-
style options on the Index, which measures changes in implied 
volatility of the SPDR S&P 500 Exchange-Traded Fund (``SPY'').\9\
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    \9\ According to the Exchange, SPY is historically the largest 
and most actively-traded exchange-traded fund in the United States 
as measured by its assets under management and the value of shares 
traded. See Notice, supra note 3, at 47042.
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    The Index is calculated using a methodology developed by 
NationsShares, which uses published real-time bid/ask quotes of SPY 
options.\10\ The Index will be calculated and maintained by a 
calculation agent acting on behalf of NationsShares. The Index will be 
updated on a real-time basis on each trading day beginning at 9:30 a.m. 
and ending at 4:15 p.m. (New York time).\11\ Values of the Index also 
will be disseminated every 15 seconds during the Exchange's regular 
trading hours to market information vendors such as Bloomberg and 
Thomson Reuters. In the event the Index ceases to be maintained or 
calculated, or its values are not disseminated every 15 seconds by a 
widely available source, the Exchange will not list any additional 
series for trading and will limit all transactions in such options to 
closing transactions only for the purpose of maintaining a fair and 
orderly market and protecting investors.
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    \10\ See id. (describing in more detail the calculation 
methodology for the Index).
    \11\ If the current published value of a component is not 
available, the last published value will be used in the calculation.
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    The Exchange proposes that the standard trading hours for index 
options (9:30 a.m. to 4:15 p.m., New York time) will apply to options 
on the Index. Options on the Index will expire on the Wednesday that is 
thirty days prior to the third Friday of the calendar month immediately 
following the expiration month. Trading in expiring options on the 
Index will normally cease at 4:15 p.m. (New York time) on the Tuesday 
preceding an expiration Wednesday. The exercise and settlement value 
will be calculated on Wednesday at 9:30 a.m. (New York time) using the 
mid-point of the NBBO for the SPY options used in the calculation of 
the Index at that time. The exercise-settlement amount is equal to the 
difference between the settlement value and the exercise price of the 
option, multiplied by $100. Exercise will result in the delivery of 
cash on the business day following expiration.
    In Amendment No. 1, the Exchange expresses its view that 
manipulation of the Index would be very difficult, particularly around 
the time when the settlement value is determined. According to the 
Exchange, the settlement value calculation for the Index, which is 
based on the mid-point NBBO of the input components, is a methodology 
unlike how other index settlement values are determined, as most are 
calculated based on transaction prices of the individual index 
components. The Exchange believes that manipulating the Index 
settlement value will be difficult based on the dynamics of a quote-
based calculation methodology as opposed to a single transaction price 
and because the option prices themselves would make such an endeavor 
cost prohibitive. Further, according to the Exchange, the vast 
liquidity of SPY options as well as the underlying SPY shares ensures a 
multitude of market participants at any given time. For example, ISE 
notes that at least 19 market makers actively traded SPY options on ISE 
during September 2013 on any given day, and there are now 12 options 
exchanges that list SPY options. Due to the high level of participation 
among market makers that can enter quotes in SPY options series, the 
Exchange believes it would be very difficult for a single participant 
to alter the NBBO width across multiple series in any significant way 
without exposing the would-be manipulator to regulatory scrutiny and 
financial costs.
    The Exchange proposes to adopt minimum trading increments for 
options on the Index to be $0.05 for series trading below $3, and $0.10 
for series trading at or above $3. The Exchange also proposes to set 
the minimum strike price interval for options on the Index at $1 or 
greater when the strike price is $200 or less, and $5 or greater when 
the strike price is greater than $200. Currently, when new series of 
index options with a new expiration date are opened for trading, or 
when additional series of index options in an existing expiration date 
are opened for trading as the current value of the underlying index 
moves substantially from the exercise prices of series already opened, 
the exercise prices of such new or additional series must be reasonably 
related to the current value of the underlying index at the time such 
series are first opened for trading.\12\ The Exchange, however, 
proposes to eliminate this range limitation that would otherwise limit 
the number of $1 strikes that may be listed in options on the Index. 
The Exchange's proposal to eliminate this range limitation is identical 
to strike

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price intervals adopted by CBOE for the CBOE Volatility Index 
(``VIX'').\13\
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    \12\ See ISE Rule 2009(c)(3). The term ``reasonably related to 
the current index value of the underlying index'' means that the 
exercise price is within thirty percent of the current index value. 
See ISE Rule 2009(c)(4).
    \13\ See Securities Exchange Act Release No. 63155 (October 21, 
2010), 75 FR 66402 (October 28, 2010) (SR-CBOE-2010-096).
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    The Exchange proposes to list options on the Index in the three 
consecutive near-term expiration months plus up to three successive 
expiration months in the March cycle.\14\ In addition, long-term option 
series having up to sixty months to expiration,\15\ Short Term Option 
Series,\16\ and Quarterly Options Series \17\ may also be traded. 
Options on the Index will be quoted and traded in U.S. dollars.\18\
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    \14\ See ISE Rule 2009(a)(3).
    \15\ See ISE Rule 2009(b)(1).
    \16\ See ISE Rule 2009, Supplementary Material .01.
    \17\ See ISE Rule 2009, Supplementary Material .02.
    \18\ See ISE Rule 2009(a)(1).
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    The Exchange believes that the Index is a broad-based index, as 
that term is defined in ISE Rule 2001(k).\19\ The Exchange proposes 
that the Index should be treated as a broad-based index for purposes of 
position limits, exercise limits, and margin requirements.\20\ 
Accordingly, the Exchange proposes no position or exercise limits for 
options on the Index \21\ and the Exchange proposes to apply margin 
requirements that are identical to those applied for its other broad-
based index options.
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    \19\ ISE Rule 2001(k) defines the terms ``market index'' and 
``broad-based index'' to mean an index designed to be representative 
of a stock market as a whole or of a range of companies in unrelated 
industries.
    \20\ In its response letter, ISE states that ISE members are 
bound by the initial and maintenance margin requirements of either 
CBOE or the New York Stock Exchange. See ISE Letter, supra note 6, 
at 3. ISE clarifies that although CBOE has margin rules designed for 
individual stock- or ETF-based volatility index options, its 
proposal intends to require compliance with CBOE's margin rules 
applicable to broad-based index options rather than its specialized 
rules adopted for specified individual stock- or ETF-based 
volatility index options. See id.
    \21\ The Exchange believes that because the Index will settle 
using published quotes of SPY options and there are currently no 
position limits for SPY options, it is appropriate not to impose 
position or exercise limits for options on the Index. The Exchange 
notes that because the size of the market underlying SPY options is 
so large, it should dispel concerns regarding market manipulation. 
The Exchange believes that the same reasoning applies to options on 
the Index since the value of options on the Index is derived from 
the volatility of SPY, as implied by SPY options. The Exchange also 
notes that VIX options are not subject to any position or exercise 
limits. See Notice, supra note 3, at 47043.
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    In addition, the Exchange proposes that the trading of options on 
the Index will be subject to the same rules that currently govern the 
trading of Exchange index options, including sales practice rules and 
trading rules. Trading of options on the Index will also be subject to 
the trading halt procedures applicable to other index options traded on 
the Exchange.\22\ Further, Chapter 6 of the Exchange's rules, which is 
designed to protect public customer trading, will apply to trading in 
options on the Index. A trading license issued by the Exchange will 
also be required for all market makers to effect transactions as market 
makers in the Index options in accordance with ISE Rule 2013.
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    \22\ See ISE Rule 2008(c).
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    The Exchange represents that it has an adequate surveillance 
program in place for options on the Index and intends to apply those 
same program procedures that it applies to the Exchange's other options 
products. Further, in Amendment No. 1, the Exchange notes that it will 
monitor for any potential manipulation of the Index settlement value 
both according to its current procedures and additional enhanced 
surveillance measures.\23\ Additionally, the Exchange notes that it is 
a member of the Intermarket Surveillance Group, through which it can 
coordinate surveillance and investigative information sharing in the 
stock and options markets with all of the U.S. registered stock and 
options markets. The Exchange also represents that it has the necessary 
system capacity to support additional quotations and messages that will 
result from the listing and trading of options on the Index.
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    \23\ Specifically, the Exchange represents that it will review 
the opening ISE BBO (``IBBO'') for the input options components to 
determine if the IBBO had an effect on the NBBO for these options 
series. If it did, the Exchange can determine which member entered 
the IBBO quote and review the member's position and quoting activity 
to determine if the quote may have been entered to impact the NBBO. 
The Exchange also represents that it will compare the Index 
settlement value to the subsequent disseminated value. If the 
difference between these two values is significant, the Exchange 
will review the opening quotes used in the calculation of the Index 
across all marketplaces to determine which exchange(s) contributed 
to opening NBBO quote(s) and contact the exchange(s) that entered 
the quote(s). See Amendment No. 1.
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III. Discussion and Commission Findings

    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 exchange.\24\ 
Specifically, the Commission finds that the proposed rule change is 
consistent with Section 6(b)(5) of the Act,\25\ which requires, among 
other things, that the rules of a national securities exchange be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, 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. Specifically, the Commission believes that the proposed Index 
options provide investors with an additional trading and hedging 
mechanism.
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    \24\ 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).
    \25\ 15 U.S.C. 78f(b)(5).
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    As noted above, the Commission received two comment letters 
regarding the proposed rule change.\26\ In its comment letters, CBOE 
argues that the Index should not be treated as a broad-based security 
index for regulatory purposes.\27\ Specifically, CBOE notes that the 
spot calculation of the Index would be comprised of a total of four 
component SPY put options and that the settlement value for the Index 
option would be calculated using the opening NBBO quotations of those 
component options.\28\ CBOE states that the component weights of the 
four put options used to calculate the Index can become highly 
concentrated in just one or two component options, depending on the 
time to expiration and the relationship of the forward SPY price to the 
strike prices of the component options.\29\ In this regard, CBOE 
questions the Exchange's proposal not to impose position limits for 
options on the Index.\30\ In particular, CBOE asserts that, although 
the Commission has permitted some broad-based security index options to 
have no position limits, the same rationale should not apply to the 
proposed Index options because they are not options on a broad-based 
security index.\31\ CBOE argues that the more analogous comparison for 
position limit treatment is the Alpha Index options that trade on 
NASDAQ OMX PHLX LLC (``Phlx'').\32\ According to CBOE, Alpha Index 
options are cash-settled index options that measure the relative 
performance of two securities (a target component and a benchmark 
component), and all approved Alpha Index pairs include SPY as the 
benchmark component.\33\ CBOE notes that Alpha Index options where the 
target component is an exchange-traded

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fund have a position limit of 15,000 contracts, and Alpha Index options 
where the target component is a single stock have a position limit of 
60,000 contracts.\34\
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    \26\ See CBOE Letter I, supra note 4 and CBOE Letter II, supra 
note 8.
    \27\ See CBOE Letter I, supra note 4 at 1-2.
    \28\ See CBOE Letter I, supra note 4 at 1 and CBOE Letter II, 
supra note 8 at 1.
    \29\ See CBOE Letter I, supra note 4 at 1 and CBOE Letter II, 
supra note 8 at 1.
    \30\ See CBOE Letter I, supra note 4 at 2-3 and CBOE Letter II, 
supra note 8 at 1.
    \31\ See CBOE Letter I, supra note 4 at 2.
    \32\ See CBOE Letter I, supra note 4 at 2 and CBOE Letter II, 
supra note 8 at 1-2.
    \33\ See CBOE Letter I, supra note 4 at 2 and CBOE Letter II, 
supra note 8 at 2.
    \34\ See CBOE Letter I, supra note 4 at 2 and CBOE Letter II, 
supra note 8 at 2.
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    In its response letter, ISE draws an analogy between the Index and 
the VIX.\35\ ISE argues that, as with the VIX, designating the Index as 
a broad-based index should not be based only on the number of 
components that the index contains, but rather, on the economic 
exposure that the underlying reference seeks to provide.\36\ ISE states 
that, according to CBOE, the VIX is a key measure of the market 
expectations of near-term volatility conveyed by options on the S&P 500 
Index.\37\ ISE asserts that the Index provides a similar economic 
exposure as exposure to the VIX because it measures changes in implied 
volatility of SPY, which is a broad-based exchange-traded fund based on 
the price and yield of the stocks held in the SPY portfolio.\38\ ISE 
therefore concludes that the Index should similarly be treated as 
broad-based by looking through to the exposure provided by the 
underlying reference.\39\
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    \35\ ISE notes that CBOE sought to designate the VIX as a broad-
based index. See ISE Letter, supra note 6, at 1.
    \36\ See id., at 2.
    \37\ See id.
    \38\ See id.
    \39\ See id.
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    ISE also argues that the proposed Index options are not analogous 
to Alpha Index options.\40\ In particular, ISE points out that Phlx's 
Alpha Index options involve the pairing of a single equity security or 
an exchange-traded fund that has a position limit against the SPY that 
has no position limit.\41\ ISE believes that, because the pairing 
includes one security that has position limits, it does not follow that 
the combined new index should have no position limits.\42\ In contrast, 
ISE believes that its proposal to apply no position limits to the Index 
options is appropriate.\43\
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    \40\ See id.
    \41\ See id.
    \42\ See id.
    \43\ See id., at 2-3. See also supra note 21 and accompanying 
text.
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    Further, as discussed above, in Amendment No. 1, ISE asserts that 
there is a low potential for manipulation of the settlement value of 
the Index due to the quote-based calculation methodology used, high 
cost that would result from any attempted manipulation, and the vast 
liquidity and high level of participation among market participants 
making manipulation very difficult.\44\ In addition, while ISE notes 
that manipulation of the Index settlement value is unlikely, it 
represents that in addition to its current surveillance procedures, it 
will undertake certain additional surveillance measures with respect to 
the Index options.\45\
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    \44\ See Amendment No. 1.
    \45\ See supra note 23 and accompanying text.
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    The Commission believes that the Exchange's proposal to impose no 
position limits on the Index options is appropriate and consistent with 
the Act.\46\ As noted above, the Index is calculated using published 
real-time bid/ask quotes of SPY options and measures changes in the 
implied volatility of the SPY. The Commission notes that SPY options 
are the most actively-traded options in terms of average daily volume. 
The Commission believes that because the options composing the Index 
are extremely liquid, the potential manipulation and potential market 
disruption concerns that position limits are designed to address are 
mitigated in the case of this product.\47\ Moreover, the Commission 
believes that having no position limits for the proposed Index options 
may benefit investors by bringing additional depth and liquidity to 
these Index options without raising significant concerns about 
potential manipulation or potential market disruption.
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    \46\ In approving this proposed rule change to list and trade 
options on the Index, the Commission is not determining whether the 
Index is a ``narrow-based'' security index as that term is defined 
in the Act. See 15 U.S.C. 78c(a)(55)(B).
    \47\ See also Amendment No. 1.
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    The Commission also believes that permitting $1.00 strike price 
intervals if the strike price is equal to or less than $200 will 
provide investors with added flexibility in the trading of these 
options and will further the public interest by allowing investors to 
establish positions that are better tailored to meet their investment 
objectives. As noted above, the Exchange proposes to provide an 
exception for the proposed Index options from the existing requirement 
that exercise prices of new or additional series must be reasonably 
related to the current value of the Index at the time such series are 
first opened for trading.\48\ The Commission believes that this change 
is consistent with the Act because it should provide investors added 
flexibility to meet their investment objectives.\49\ The Commission 
also notes that the Exchange has represented that it has the necessary 
systems capacity to handle the additional traffic associated with the 
listing and trading of this new product and it expects that the 
Exchange considered this expansion of the permissible range of strike 
prices in making such a representation.\50\
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    \48\ See supra notes 12-13 and accompanying text.
    \49\ The Commission notes that CBOE recently eliminated the band 
that limited the number of $1 strikes that could be listed on VIX 
options. See Securities Exchange Act Release No. 63155 (October 21, 
2010), 75 FR 66402 (October 28, 2010) (SR-CBOE-2010-096).
    \50\ See Notice, supra note 3, at 47044.
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    The Commission also believes that it is consistent with the Act to 
apply margin requirements to the proposed Index options that are 
otherwise applicable to options on broad-based indexes.\51\ The 
Commission further believes that the Exchange's proposed minimum 
trading increment, series openings, and other aspects of the proposed 
rule change are appropriate and consistent with the Act.
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    \51\ See supra note 20.
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    As a national securities exchange, the Exchange is required, under 
Section 6(b)(1) of the Act,\52\ to enforce compliance by its members 
and persons associated with its members with the provisions of the Act, 
Commission rules and regulations thereunder, and its own rules. In this 
regard, the Commission notes that trading of options on the Index will 
be subject to the same rules that currently govern the trading of other 
index options on the Exchange.\53\ In addition, as noted above, the 
Exchange has asserted that manipulation of the Index settlement value 
will be difficult.\54\ Moreover, the Exchange has represented that it 
has an adequate surveillance program in place for options traded on the 
Index, and will monitor for any potential manipulation of the Index 
settlement value according to its current surveillance procedures and 
additional surveillance measures.\55\ In approving the proposed listing 
and trading of the Index options, the Commission has also relied on 
ISE's representation that it has the necessary systems capacity to 
support the new options series that will result from this proposal.\56\
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    \52\ 15 U.S.C. 78f(b)(1).
    \53\ See supra note 22 and accompanying text.
    \54\ See Amendment No. 1.
    \55\ See Notice, supra note 3, at 47044 and Amendment No. 1.
    \56\ See Notice, supra note 3, at 47044.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\57\ that the proposed rule change (SR-ISE-2013-42), as modified by 
Amendment No. 1, be, and hereby is, approved.
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    \57\ 15 U.S.C. 78s(b)(2).


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    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\58\
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    \58\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-01510 Filed 1-27-14; 8:45 am]
BILLING CODE 8011-01-P


