[Federal Register Volume 63, Number 133 (Monday, July 13, 1998)]
[Rules and Regulations]
[Pages 37668-37688]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-18292]
[[Page 37667]]
_______________________________________________________________________
Part III
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Part 240
Reports to be Made by Certain Brokers and Dealers and Year 2000
Readiness Reports to be Made by Certain Transfer Agents; Final and
Proposed Rules
Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 / Rules
and Regulations
[[Page 37668]]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-40162; File No. S7-7-98]
RIN 3235-AH36
Reports to be Made by Certain Brokers and Dealers
AGENCY:Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
amending Rule 17a-5 under the Securities Exchange Act of 1934
(``Exchange Act'') to require broker-dealers to file with the
Commission and their designated examining authority (``DEA'') at
designated times two separate reports regarding their Year 2000
compliance. The reports will increase broker-dealer awareness that they
should be taking specific steps now to prepare for the Year 2000;
facilitate coordination with self regulatory organizations of industry-
wide testing, implementation, and contingency planning; supplement the
Commission's examination module for Year 2000 issues and identify
potential Year 2000 problems; and provide information regarding the
securities industry's preparedness for the Year 2000. The reports are
designed to be available to the public which will enable broker-dealer
counterparties and others to assess the risks of doing business with a
broker-dealer that may not be Year 2000 compliant.
EFFECTIVE DATE: August 12, 1998.
FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, 202/942-0131; Thomas K. McGowan, Assistant Director, 202/942-
4886; Lester Shapiro, Senior Accountant, 202/942-0757; or Christopher
M. Salter, Staff Attorney, 202/942-0148, Division of Market Regulation,
Securities and Exchange Commission, 450 Fifth Street, NW, Mail Stop 10-
1, Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Introduction
At midnight on December 31, 1999, unless the proper modifications
have been made, the program logic in many of the world's computer
systems will start to produce erroneous results because, among other
things, the systems will incorrectly read the date ``01/01/00'' as
being the year 1900 or another incorrect date. In addition, systems may
fail to detect that the Year 2000 is a leap year. Problems can also
arise earlier than January 1, 2000, as dates in the next millennium are
entered into non-Year 2000 compliant programs.
The Commission views the Year 2000 problem as an extremely serious
issue. A failure to assess properly the extent of the problem,
remediate systems that are not Year 2000 compliant, and then test those
systems could endanger the nation's capital markets and place at risk
the assets of millions of investors. In light of this, both the broker-
dealer industry and the Commission are working hard to address the
industry's Year 2000 problems.
As part of its ongoing efforts relating to the Year 2000, on March
5, 1998, the Commission requested comment on proposed amendments to
Rule 17a-5 \1\ that would require certain broker-dealers to file
reports with the Commission and their DEA regarding Year 2000
compliance.\2\ In particular, the Commission sought comment on: (i) the
definition of the term ``Year 2000 Problem;'' \3\ (ii) the minimum net
capital reporting threshold; (iii) the proposed reporting content; (iv)
the requirement that portions of the report be attested to by
independent public accountants; and (v) the public availability of the
information to be reported.
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\1\ 17 CFR 240.17a-5. Rule 17a-5 was adopted by the Commission
pursuant to authority under Section 17 of the Exchange Act [15
U.S.C. 78q], and particularly Section 17(e) [15 U.S.C. 78q(e)],
which requires every broker- dealer to file annually with the
Commission a certified balance sheet and income statement, and such
officer information concerning its financial condition as the
Commission may prescribe.
\2\ Release Nos. 34-39724; IC-23059; IA-1704, (March 5, 1998),
63 FR 12056 (March 12, 1998) (''Proposing Release'').
\3\ The Proposing Release defined the term ``Year 2000 Problem''
to include any erroneous result caused by any computer software (i)
incorrectly reading the date ``01/01/00'' or any year thereafter;
(ii) incorrectly identifying a date in the year 1999 or any year
thereafter; (iii) failing to detect that the Year 2000 is a leap
year, and (iv) any other computer error that is directly or
indirectly related to (i), (ii), or (iii) above.
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The Commission received 35 comment letters in response to the
Proposing Release.\4\ The majority of the commenters generally
supported the Commission's proposals and made suggestions for improving
one or more aspects of the proposed amendments.\5\ However, the
majority of the commenters objected to the attestation requirement and
the $100,000 minimum net capital threshold for determining which
broker-dealers would be required to file Year 2000 reports under the
proposed amendments. The majority of the commenters that addressed the
issue of whether the information reported should be publicly available,
objected to the Year 2000 reports and related accountant's attestation
report being made public. Based on the comments received, the
Commission is adopting the proposed amendments with the changes
discussed below.
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\4\ All comment letters are available in File No. S7-7-98 at the
Commission's Public Reference Room, 450 Fifth Street, NW,
Washington, DC 20549. The comment period closed on April 27, 1998.
See also Release Nos. 34-39858; IC-23112; IA-1716 (extending the
comment period from April 13, 1998 to April 27, 1998).
\5\ Of the 35 comment letters received, five were opposed to any
additional regulatory requirements.
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II. Description of the Proposed Rule Amendments
Under the proposed amendments, a broker-dealer that is required to
maintain minimum net capital of $100,000 or greater as of either
December 31, 1997, or December 31, 1998, would have been required to
file two reports at specified times with the Commission and its DEA
regarding its efforts to address Year 2000 Problems. The first of these
reports would have evaluated the efforts of the broker-dealer as of
December 31, 1997, and would have been required to be filed no later
than 45 days after the Commission adopted the proposed rule amendments.
The second report would have evaluated the broker-dealer's efforts as
of the date of its financial statements for fiscal year-end 1998. This
report would have been required to be filed within 90 days after the
date of its fiscal year-end financial statements.
As part of the second report, each reporting broker-dealer would
have been required to make assertions about its efforts to prepare for
the Year 2000. For example, a broker-dealer would have been required to
assert whether or not it has a plan to address Year 2000 Problems. In
addition to making the assertions, each reporting broker-dealer would
have been required to engage an independent public accountant to attest
to whether there was a reasonable basis for the broker-dealer's
assertions.\6\
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\6\ The broker-dealer's assertions and the related accountant's
attestation report would have been required to be filed only with
the second report.
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As noted in the Proposing Release, the Commission has advised
broker-dealers that if a broker-dealer's computer systems have Year
2000 Problems, the broker-dealer may be deemed not to have accurate and
current records and be in violation of Rule 17a-3 under the Exchange
Act.\7\ The Commission also reminded broker-dealers that Rule 17a-11
under the Exchange Act requires every broker-dealer to promptly notify
[[Page 37669]]
the Commission of its failure to make and keep current books and
records.\8\
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\7\ 17 CFR 240.17a-3.
\8\ 17 CFR 240.17a-11(d).
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III. Discussion of Final Rule Amendments
A. Reporting Threshold
In the Proposing Release, the Commission proposed the $100,000
minimum net capital reporting threshold because broker-dealers subject
to this minimum net capital level are likely to have substantial
financial exposure to the market and to customers. This threshold would
have required all dealers, market makers, and clearing firms to file
the Year 2000 reports.
Several commenters, including the National Association of
Securities Dealers (``NASD''), expressed concern about the proposed net
capital threshold because that threshold excludes nearly 72% of all
registered broker-dealers from reporting on their efforts to address
Year 2000 Problems.\9\ These commenters stated that the Commission's
proposal does not gather adequate information regarding the risks posed
by the Year 2000 because the proposed threshold would exclude many
firms that execute thousands of transactions each trading day effecting
thousands of customers, market makers, and dealers. These commenters
argued that the failure on the part of a large number of excluded
broker-dealers to adequately prepare for the Year 2000 could have
negative systemic effects on the world's financial markets.
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\9\ As explained in the Proposing Release, under the proposed
$100,000 net capital threshold, approximately 5,600 out of 7,800
registered broker-dealers would be exempt from the Year 2000
reporting requirements.
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While mindful of the burden on small broker-dealers, the Commission
is addressing this comment by requiring each broker-dealer with a
minimum net capital requirement of $5,000 or greater to file reports
with the Commission and with its DEA that discuss its efforts to
address Year 2000 Problems. Broker-dealers that have a minimum net
capital requirement of less than $100,000 will only be required to file
a less burdensome check-the-box style Year 2000 report. Broker-dealers
that meet a $100,000 minimum net capital reporting threshold will be
required to file, in addition to the check-the-box report, a more
detailed narrative discussion of their Year 2000 efforts. The format
for broker-dealers to report on their efforts to address Year 2000
Problems is discussed in more detail in paragraph III.F. below.
B. Attestation Requirement
The Proposing Release would have required each broker-dealer to
have an independent public accountant attest to several specific
assertions included in the second Year 2000 report. The Commission
believed it was important to have an independent third party affirm
that there was a reasonable basis supporting the broker-dealer's
assertions.
As proposed, each broker-dealer would have been required to assert:
(1) whether it has developed written plans for preparing and
testing its computer systems for potential Year 2000 Problems;
(2) whether the board of directors, or similar body, has approved
these plans, and whether a member of the broker-dealer's board of
directors, or similar body, is responsible for executing the plans;
(3) whether its Year 2000 remediation plans address all domestic
and international operations, including the activities of its
subsidiaries, affiliates, and divisions;
(4) whether it has assigned existing employees, hired new
employees, or engaged third parties to execute its Year 2000
remediation plans; and
(5) whether it has conducted internal and external testing of its
Year 2000 solutions and whether the results of those tests indicate
that the broker-dealer has modified its software to correct Year 2000
problems.
The American Institute of Certified Public Accountants (``AICPA'')
commented that the required attestation report would be difficult for
independent public accountants to provide. The AICPA said that some of
the required broker-dealer assertions are not appropriate for
accountant attestation because the assertions are not capable of
reasonably consistent measurement against reasonable criteria.
Currently, there are no established criteria related to Year 2000
remediation efforts. The lack of established criteria would likely
result in significant variation in the examination procedures performed
by independent public accountants and thus reduce the usefulness of the
attestation reports. In addition, the AICPA expressed concern that the
purpose and conclusions of the attestation report could be
misunderstood. The AICPA was primarily concerned that uninformed users
of the attestation reports would place undue reliance on them.
The AICPA suggested that an ``agreed-upon procedures'' engagement,
instead of an attestation engagement, would more effectively meet the
Commission's goals. Pursuant to such an engagement, a broker-dealer
would engage an independent public accountant to perform and report on
specific procedures designed to meet the Commission's objectives. This
would eliminate the variability of examination procedures performed by
independent public accountants and thus increase the consistency of the
reports received by the Commission. The AICPA's letter outlined
elements of an agreed-upon procedures report and offered to follow-up
with the Commission staff regarding the development of specific
procedures for a Year 2000 engagement.
The Commission is deferring consideration of whether to adopt a
requirement that the second report be evaluated by an independent
public accountant. The Commission, however, will consider such a
requirement if the accounting industry recommends a standard which can
be used by public accountants in connection with the second report.\10\
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\10\ In light of the AICPA's comment letter and ongoing efforts,
in a companion release also issued today the Commission is re-
opening the comment period with respect to the proposal to have an
independent public accountant review a broker-dealer's second Year
2000 report. The public file (No. S7-7-98) will include both the
AICPA's original comment letter and any follow-up letter submitted
by the AICPA for the Commission's consideration.
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C. Public Availability
The proposed rules would have made a broker-dealer's Year 2000
reports, including the attestation by the independent public
accountant, available to the public. The Commission recognizes
commenters' concerns that some users of these reports could place undue
reliance on the reports, the technical nature of the reports could
confuse investors, detailed testing reports could be misleading and
unnecessarily alarming, and the reports could contain confidential
proprietary information.
However, the Commission believes that the public's interest is best
served by requiring full and open disclosure. Allowing the public,
particularly other broker-dealers and counterparties, to have access to
the information reported by broker-dealers will enable interested
persons to assess the Year 2000 readiness of a broker-dealer with which
they are doing business. For example, after receiving a counterparty's
report, another broker-dealer might request additional information or
assurances if the counterparty does not appear to be taking the steps
necessary to be Year 2000 compliant. In the absence of such assurances,
the other broker-dealer could determine whether it wishes to
[[Page 37670]]
continue its dealings with that broker-dealer.
Accordingly, the final rule provides that these reports will be
available to the public.
D. Timing
The Proposing Release established as-of dates and due dates for the
reports broker-dealers were required to file.\11\ Some commenters
explained that, in the absence of an existing requirement to make and
retain records detailing Year 2000 remediation efforts as of December
31, 1997, the information to prepare the reports may not be available.
In addition, several commenters stated that reporting Year 2000 status
as of December 31, 1997 would provide data that is outdated and
misleading. Finally, some broker-dealers commented that they have
fiscal years that end in mid to late 1998, and that the proposed due
dates and as-of-dates for the first and second reports would have
required some broker-dealers to file their reports virtually back-to-
back.
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\11\ The first of these reports would have evaluated the efforts
of broker-dealers as of December 31, 1997, and would have been
required to be filed no later than 45 days after the Commission
adopted the proposed rule amendments. The second report would have
evaluated broker-dealer efforts as of the date of their financial
statements for fiscal year-end 1998. This report would have been
required to be filed within 90 days after the date of their
financial statements.
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The rule adopted by the Commission today requires a broker-dealer
to file its first report with the Commission and its DEA by August 31,
1998. This report should reflect the status of the broker-dealer's Year
2000 efforts as of July 15, 1998. The second report must be filed with
the Commission and the broker-dealer's DEA by April 30, 1999, and
should reflect the status of the broker-dealer's Year 2000 efforts as
of March 15, 1999.
The rule adopted today also requires new broker-dealers who
register as a broker-dealer between July 16, 1998 and December 31,
1998, to file with the Commission and its DEA no later than 30 days
after its registration becomes effective the first report on its Year
2000 compliance as of the date of its registration. In addition, the
rule also requires new broker-dealers who register as a broker-dealer
between March 16, 1999 and October 1, 1999, to file with the Commission
and its DEA no later than 30 days after its registration becomes
effective a report on its Year 2000 compliance as of the date of its
registration.\12\
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\12\ New broker-dealers who register between January 1, 1999 and
March 15, 1999, are required to file a report on their Year 2000
efforts no later than April 30, 1999. This report should reflect
their Year 2000 efforts as of March 15, 1999.
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E. Reporting Requirements
As previously discussed, the Proposing Release would have required
each reporting broker-dealer to discuss the steps it has taken to
address Year 2000 Problems. More specifically, each broker-dealer would
have been required to (i) indicate whether its board of directors, or
similar body, has approved and funded written Year 2000 remediation
plans that address all major computer systems; (ii) describe its Year
2000 staffing efforts, and the work performed by Year 2000 dedicated
staff; \13\ (iii) discuss its progress on each stage of preparation for
the Year 2000; \14\ (iv) indicate if it has written contingency plans
to deal with Year 2000 problems that may occur; \15\ and (v) identify
what levels of management are responsible for Year 2000 remediation
efforts.
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\13\ This includes whether the broker-dealer has assigned
existing employees, hired new employees, or engaged third parties to
provide assistance in avoiding Year 2000 Problems.
\14\ These stages are: (i) awareness of potential Year 2000
Problems; (ii) assessment of what steps must be taken to avoid Year
2000 Problems; (iii) implementation of the steps needed to avoid
Year 2000 Problems; (iv) internal testing of software designed to
avoid Year 2000 Problems; (v) integrated or industry-wide testing of
software designed to avoid Year 2000 Problems (including testing
with other broker-dealers, other financial institutions, customers,
and vendors); and (vi) implementation of tested software that will
avoid Year 2000 Problems.
\15\ Contingency planning should provide for adequate
protections to ensure the success of critical systems if interfaces
fail or unexpected problems are experienced with operating systems
and infrastructure software. In addition, contingency plans should
provide for the failure of external systems that interact with the
broker-dealer's computer system. For example, contingency plans
should anticipate the failure of a vendor that services mission
critical applications and should provide for the potential that a
significant customer experiences difficulty due to Year 2000
problems.
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The Securities Industry Association (``SIA'') suggested some
changes to the specific reporting requirements to better clarify the
information sought by the Commission. For example, the Proposing
Release would have required broker-dealers to discuss the work
performed by Year 2000 dedicated staff on an individual basis. In
addition, broker-dealers would have been required to identify the
levels of management involved in the Year 2000 efforts, discuss the
specific responsibilities of these managers, and provide an estimate of
the time they have spent on Year 2000 efforts. The SIA explained that
these proposed requirements may be very burdensome. Fixing Year 2000
problems may require the dedicated efforts of a significant number of
employees and consultants. In addition, the tasks and responsibilities
involved may be detailed, extensive, and constantly changing.
The proposed rule also would have required broker-dealers to report
the number and nature of the exceptions resulting from both internal
and integrated testing of software designed to avoid Year 2000
Problems. The SIA commented that this requirement would likely provide
meaningless information. The SIA explained that testing software is a
dynamic process that in many instances requires exceptions to be
identified hourly, daily, and weekly. In addition, identified
exceptions may be immediately addressed, causing new exceptions to
emerge. This process may repeat itself many times before testing is
finished. Consequently, by the time the Commission received the Year
2000 reports, the exceptions discussed in them may have been addressed
and new exceptions identified.
The Commission agrees that some modification of the reporting
requirements is warranted. The rule adopted today requires each broker-
dealer completing the narrative portion of Form BD-Y2K to provide a
summary of the efforts of Year 2000 dedicated individuals or groups of
individuals. The broker-dealer will not have to provide an estimate of
the time that its management has spent on Year 2000 efforts. Finally,
the broker-dealer must report the number and description of material
exceptions identified during the internal and external testing of its
software that are unresolved as of the report date. The Commission is
leaving the determination of what constitutes a material exception to
the broker-dealer's judgment.
F. Report Format
The Proposing Release would have required each broker-dealer
meeting the $100,000 minimum net capital threshold to discuss, in
narrative format, its efforts to address Year 2000 Problems. The
National Association of Securities Dealers Regulation, Inc. (``NASDR'')
commented that the Commission should prescribe a format for a broker-
dealer to use when reporting on its Year 2000 efforts. More
specifically, the NASDR suggested that the Commission prescribe an
objective reporting format, such as a check-the-box questionnaire. The
NASDR explained that an open narrative format may lead to great
disparity in the nature and detail of the reports that broker-dealers
would submit. Providing a reporting format would produce consistent
results, improve the accuracy and comparability of reports received,
and reduce the time required to
[[Page 37671]]
summarize, track, analyze, and report the information received.
The Commission recognizes the value of receiving the requested
information in an objective format and that prescribing such a format
would decrease the burden that the Year 2000 reporting requirements
impose on broker-dealers. However, the Commission also is concerned
that limiting the reporting requirements to a check-the-box format for
broker-dealers that pose the greatest risk to customers and the market
will not provide the Commission or the DEAs sufficient information to
effectively review for Year 2000 compliance.
The rule the Commission adopts today requires each broker-dealer
with a minimum net capital requirement of $5,000 or greater to file
with the Commission and its DEA Part I of a new Form BD-Y2K.\16\ Part I
of Form BD-Y2K is a check-the-box Year 2000 report that generally
addresses the same issues the proposed narrative discussion addresses.
Each broker-dealer that is required to maintain net capital of $100,000
or greater will be required to file Part II of Form BD-Y2K, which
requires a narrative discussion of its efforts to address Year 2000
Problems. The narrative discussion is designed to provide the
Commission and the DEA's with additional information on the Year 2000
efforts of those broker-dealers who pose the greatest risk to customers
and the market if they are not Year 2000 compliant.
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\16\ For a copy of Form BD-Y2K see Attachment A.
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Copies of Form BD-Y2K are available in Commission's Public
Reference Room located at 450 Fifth Street, NW, Washington, DC 20549 or
copies can be obtained from the Commission's internet web site at the
following address: www.sec.gov.
IV. Costs and Benefits of the Rules and Their Effects on
Competition, Efficiency, and Capital Formation
Section 23(a) of the Exchange Act \17\ requires the Commission, in
adopting rules under the Exchange Act, to consider the competitive
effects of such rules and to not adopt a rule that would impose a
burden on competition not necessary or appropriate in furthering the
purposes of the Exchange Act. Furthermore, Section 3(f) of the Exchange
Act \18\ provides that whenever the Commission is engaged in rulemaking
and is required to consider or determine whether an action is necessary
or appropriate in the public interest, the Commission also shall
consider, in addition to the protection of investors, whether the
action will promote efficiency, competition, and capital formation.
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\17\ 15 U.S.C. 78w (a)(2).
\18\ 15 U.S.C. 78c.
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The Commission has considered the amendments to Rule 17a-5 in light
of the standards cited in Sections 3 and 23 (a)(2) of the Exchange Act.
In the Proposing Release, the Commission requested that commenters
provide analysis and data supporting the costs and benefits of the
proposed amendments. In addition, the Commission sought comments on the
proposed amendments' effect on competition, efficiency, and capital
formation.
Several commenters indicated that the Commission's cost estimates
were too low. However, no commenters provided detailed information or
data as to the costs of the proposed amendments. One commenter
addressed the issue of whether the proposed amendments would affect
competition. Finally, no comments were received regarding the proposed
amendments effect on efficiency and capital formation.
A. Cost Benefit Analysis
Based on comments received, the Commission has revised the proposed
amendments the result of which is to lower the aggregate cost of
compliance with the rule. As discussed above, the Commission is
adopting new Form BD-Y2K and is expanding the requirement that a
broker-dealer report on its Year 2000 efforts to each broker-dealer
with a minimum net capital requirement of $5,000 or greater. Each of
these broker-dealers is required to file Part I of Form BD-Y2K, a
check-the-box Year 2000 report. Each broker-dealer that meets the
$100,000 minimum net capital reporting threshold is required to also
complete Part II of Form BD-Y2K.
The Commission is also deferring consideration of whether to
require broker-dealers to engage independent public accountants to
examine their efforts to address Year 2000 Problems. The Commission is
allowing broker-dealers to summarize by group the efforts of Year 2000
dedicated individuals as opposed to requiring individual descriptions
of these people's efforts. Broker-dealers will not have to provide an
estimate of the time management has spent on Year 2000 efforts.
Finally, broker-dealers are only required to report the number and
description of unresolved material exceptions identified during the
internal and external testing of their software.
Based on field testing of Part I of Form BD-Y2K conducted by the
Office of Compliance Inspections and Examinations, the Commission
estimates that on average a broker-dealer will spend approximately two
hours completing Part I of Form BD-Y2K resulting in a total cost to the
industry of $2,400,000.\19\ This is based on 6,000 respondents spending
four hours at $100 per hour preparing two reports consisting of Part I
of Form BD-Y2K. The Commission estimates that on average a broker-
dealer will spend 35 hours completing Part II of Form BD-Y2K resulting
in a total cost to the industry of $15,400,000. This is based on 2,200
broker-dealers spending 70 hours at $100 per hour preparing two reports
consisting of Part II of Form BD-Y2K. Therefore, based upon the
adjustments to the proposed rule, the Commission has revised its cost
to the industry to a total of $17,800,000 ($2,400,000 + $15,400,000).
It is important to note that this is a total cost estimate and not an
annual cost. Broker-dealers will only be required to prepare and file
two Form BD-Y2Ks.
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\19\ Field tests of Part I of Form BD-Y2K indicated that it
could be completed in as little as 30 minutes. However, the
Commission believes that it may take longer for some broker-dealers
to complete Part I of Form BD-Y2K.
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No commenters addressed the potential benefits of the amendments,
and the Commission has not been able to quantify those benefits.
However, the Commission believes that the benefits will outweigh the
costs. The Commission is aware of the significant effort the securities
industry has put forth and the progress it has made but believes that
significant progress still needs to be made by the securities industry
to be ready for the Year 2000.
The Commission does not yet have comprehensive information
regarding the readiness of the broker-dealer industry for the Year
2000. Although the NASD and the NYSE have conducted surveys of their
members, not all members responded to the survey and some of those who
did submitted incomplete responses. It is important for the Commission
to obtain complete information from individual broker-dealers to permit
the Commission and Self Regulatory Organizations (``SROs'') to assess
the risks associated with firms that fail to show adequate Year 2000
progress. Moreover, the Commission believes that a regulatory
requirement to file Year 2000 reports should encourage broker-dealers
to proceed expeditiously with their efforts to prepare for the Year
2000. The Commission will use the reported information to obtain a more
complete understanding of the industry's overall Year 2000 preparations
and to identify firm-specific and industry-wide problems. Information
in the reports will help the
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Commission focus its Year 2000-related efforts for the rest of 1998 and
1999 on particular industry segments or firms that appear to pose the
greatest risk of non-compliance.
In sum, the rule amendments will enable the Commission to take a
more active role in reducing the Year 2000 risk to the securities
industry. The reports broker-dealers will be required to file will
enable the Commission and the SROs to (i) better monitor the industry's
Year 2000 readiness; (ii) increase broker-dealer awareness that they
should be aggressively preparing for the Year 2000; (iii) coordinate
industry-wide testing, implementation, and contingency planning; and
(iv) enable the Commission to identify potential compliance problems.
B. Efficiency, Competition, and Capital Formation
In the Proposing Release, the Commission stated that the proposed
amendments should not unduly burden competition. One commenter
addressed the proposed amendment's effect on competition. This
commenter stated that the proposed amendments could have an
anticompetitive effect because the amendments exclude nearly 72% of
registered broker-dealers from having to report on their efforts to
address Year 2000 Problems.
The Commission has drafted the rule amendments so as to minimize
their impact on competition. As discussed above, the Commission
adjusted the proposed amendments to require each broker-dealer with a
minimum net capital requirement of $5,000 or greater to report on its
Year 2000 efforts in order to gather adequate information regarding the
industry-wide risks posed by the Year 2000 Problem. However, the
Commission has structured the form of the report to differentiate
between broker-dealers based upon their size, type of business, and
relative risk they pose to customers and the market if they are not
Year 2000 compliant. Broker-dealers that do not meet the $100,000
minimum net capital reporting threshold are only required to file the
Year 2000 report. Broker-dealers that meet the $100,000 minimum net
capital reporting threshold are required to provide additional
information. The Commission believes that the proposed amendments do
not impose any burden on competition not necessary or appropriate in
furtherance of the Exchange Act.
The Commission believes that the amendments should increase the
efficiency and effectiveness of the industry's efforts to prepare for
the Year 2000 by increasing awareness, focusing industry efforts, and
providing critical information for identifying and remedying problems.
In addition, the Commission believes that the amendments do not
adversely affect capital formation. However, failure on the part of the
securities industry to adequately prepare for the Year 2000 could
adversely affect capital formation at the beginning of the next
millennium.
V. Summary of Final Regulatory Flexibility Analysis
A final Regulatory Flexibility Analysis (``FRFA'') concerning the
amendments to Rule 17a-5 has been prepared in accordance with the
provisions of the Regulatory Flexibility Act (``RFA''), as amended by
Pub. L. 104-121, 110 Stat. 847, 864 (1996), 5 U.S.C. 604. The FRFA
notes that the amendments to Rule 17a-5 will enable the Commission to
(i) monitor the steps broker-dealers are taking to address Year 2000
Problems; (ii) increase broker-dealer awareness that they should be
taking specific steps now to prepare for the Year 2000; (iii)
facilitate coordination with SROs on industry-wide testing,
implementation, and contingency planning; and (iv) supplement the
Commission's examination module for Year 2000 issues.
The Commission received no comments on the Initial Regulatory
Flexibility Analysis (``IRFA'') prepared in connection with the
proposing release, and no comment letters specifically addressed the
IRFA. However, as discussed in paragraphs III.A and IV.A above, certain
commenters expressed concern about the threshold for determining which
broker-dealers are required to report on their efforts to prepare for
the Year 2000, and the estimated costs associated with obtaining the
independent public accountant's attestation.
As discussed more fully in the FRFA, the rule will affect small
entities. When used with reference to a broker or dealer, the
Commission has defined the term ``small entity'' to mean a broker or
dealer (``small broker-dealer'') that: (1) had total capital (net worth
plus subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to section 240.17a-5(d) or, if not required to file
such statements, a broker or dealer that had total capital (net worth
plus subordinated liabilities) of less than $500,000 on the last
business day of the preceding fiscal year (or in the time that it has
been in business, if shorter); and (2) is not affiliated with any
person (other than a natural person) that is not a small business or
small organization as defined in this release.\20\
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\20\ 17 CFR 240.0-10(c).
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Based on FOCUS data for the fourth quarter of 1996, the latest
information available, the Commission estimates that there are
approximately 5,300 small broker-dealers. Of these 5,300 small broker-
dealers, approximately 3,800 are affected by the amendments to Rule
17a-5.\21\
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\21\ The proposed rule amendments would have affected
approximately 600 small broker-dealers. The reasons for expanding
the Year 2000 reporting requirements are discussed in paragraph
III.A. above.
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The Commission has drafted the rule amendments so as to minimize
their impact on small broker-dealers while enhancing investor
protection and minimizing any impact on competition, in part, by
adopting different reporting requirements to take into account the
resources available to small broker-dealers. The rule amendments
require broker-dealers with a minimum net capital requirement of $5,000
or greater to report on their efforts to address Year 2000 problems.
However, approximately 1,500 small broker-dealers who do not have a
minimum net capital requirement are exempt from reporting on their Year
2000 efforts. In addition, the Commission has adopted two reporting
formats for broker-dealers to use when reporting on their efforts to
prepare for the Year 2000.
Of the 3,800 small broker-dealers required to report on their Year
2000 efforts, approximately 3,200 (84%) are only required to file a
check-the-box style Year 2000 report. As noted in the cost-benefit
section above, the Commission estimates that it would take each of
these broker-dealers approximately 2 hours to complete the check-the-
box Year 2000 report. The remaining 600 (16%) small broker-dealers are
required to provide, in addition to the check-the-box style report, a
more extensive narrative discussion of their Year 2000 efforts because
the type of business that these broker-dealers conduct poses a greater
risk to customers and the market if they are not Year 2000 compliant.
Thus, by adopting different reporting requirements and by exempting
those broker-dealers who do not have a minimum net capital requirement,
the Commission has imposed no burden, or only a very limited burden, on
approximately 4,700 (89%) small broker-dealers.
The FRFA notes that it would be difficult to further simplify,
consolidate, or adjust compliance standards for small broker-dealers
and be able to effectively monitor the securities industry's efforts
[[Page 37673]]
to prepare for the Year 2000. The Commission believes that the
alternative reporting requirement adopted for small broker-dealers
strikes the appropriate balance between the need to protect investors
and the need to minimize the impact on small broker-dealers. The
Commission also considered the use of performance rather than design
standards. However, the Commission concluded that it would be
inconsistent with the purpose of the rule to use performance standards
to specify different requirements for small entities.
A copy of the FRFA may be obtained by contacting Christopher M.
Salter, Staff Attorney, U.S. Securities and Exchange Commission, Mail
stop 10-1, 450 Fifth Street, NW., Washington, DC 20549.
VI. Paperwork Reduction Act
As set forth in the Proposing Release, the amendments to Rule 17a-5
contain collections of information within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\22\ Accordingly, the collection of
information requirements were submitted to the Office of Management and
Budget (``OMB'') for review and were approved by OMB which assigned the
following control number 3235-0511.
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\22\ 44 U.S.C. 3501 et seq.
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The Proposing Release solicited comments on the proposed
collections of information. No comments were received that specifically
addressed the PRA submission. However, as discussed in sections III.
and IV. above, the Commission received suggestions that would improve
the collections of information. Based upon these suggestions, the
collections of information have been adjusted as described in sections
III. above and are in accordance with Section 3507 of the PRA.\23\
These adjustments include the adopting of two reporting formats to
increase the consistency, accuracy and comparability of the information
collected. In addition, the adjustments will reduce the time required
to summarize, track, analyze, and report the information received.
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\23\ 44 U.S.C. 3507.
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An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the agency displays a
valid OMB control number. Broker-dealers are required to comply with
the collection of information pursuant to the amendments to Rule 17a-5
and the information is necessary to provide the Commission with a
better understanding of the security industry's readiness for the Year
2000. The information collected pursuant to the amendments to Rule 17a-
5 will be public.
Based upon the adjustments to the amendments, the Commission is
adjusting its burden estimate. The Commission estimated in the
Proposing Release that, on average, a broker-dealer would spend 70
hours preparing the Year 2000 report and obtaining the independent
public accountant's Attestation. The Commission estimates that under
the final amendments, a broker-dealer will, on average, spend two hours
preparing Part I of Form BD-Y2K and 35 hours preparing Part II of Form
BD-Y2K. The total annualized burden to the securities industry is
estimated to be 89,000 hours. This is based on 6,000 respondents
spending two hours preparing Part I and 2,200 respondents spending 35
hours preparing Part II of Form BD-Y2K.
VII. Statutory Analysis
Pursuant to the Securities Exchange Act of 1934 and particularly
Sections 17(a) and 23(a) thereof, 15 U.S.C. 78o(c)(3) and 78w, the
Commission is adopting amendments to Sec. 240.17a-5 of Title 17 of the
Code of Federal Regulations in the manner set forth below.
List of Subjects in 17 CFR Parts 240 and 249
Broker-dealers, Reporting and recordkeeping requirements,
Securities.
Text of Final Rule
In accordance with the foregoing, Title 17, chapter II, part 240 of
the Code of Federal Regulations is amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934.
1. The authority citation for part 240 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee,
77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k,
78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d),
78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and
80b-11, unless otherwise noted.
* * * * *
2. By amending Sec. 240.17a-5 by adding paragraph (e)(5) to read as
follows:
Sec. 240.17a-5 Reports to be made by certain brokers and dealers.
* * * * *
(e) Nature and form of reports. * * *
(5)(i) For purposes of this section, the term Year 2000 Problem
shall include problems arising from:
(A) Computer software incorrectly reading the date ``01/01/00'' as
being the year 1900 or another incorrect year;
(B) Computer software incorrectly identifying a date in the Year
1999 or any year thereafter;
(C) Computer software failing to detect that the Year 2000 is a
leap year; or
(D) Any other computer software error that is directly or
indirectly caused by the problems set forth in paragraph (e)(5)(i)(A),
(B), or (C) of this section.
(ii) (A) No later than August 31, 1998, every broker or dealer
required to maintain minimum net capital pursuant to Sec. 240.15c3-
1(a)(2) of $5,000 or greater as of July 15, 1998, shall file Part I of
Form BD-Y2K (Sec. 249.618 of this chapter) prepared as of July 15,
1998, and no later than April 30, 1999, every broker or dealer required
to maintain minimum net capital pursuant to Sec. 240.15c3-1(a)(2) of
$5,000 or greater as of March 15, 1999, shall file Part I of Form BD-
Y2K prepared as of March 15, 1999.
(B) Every broker or dealer that registers pursuant to section 15 of
the Act between July 16, 1998 and December 31, 1998 or between March
16, 1999 and October 1, 1999, and that is required to maintain net
capital pursuant to Sec. 240.15c3-1(a)(2) of $5,000 or greater, shall
file Part I of Form BD-Y2K (Sec. 249.18 of this chapter) no later than
30 days after its registration becomes effective. Part I of Form BD-Y2K
shall be prepared as of the date its registration became effective.
(iii)(A) No later than August 31, 1998, every broker or dealer with
a minimum net capital requirement pursuant to Sec. 240.15c3-1(a)(2) of
$100,000 or greater as of July 15, 1998 shall file Part II of Form BD-
Y2K (Sec. 249.618 of this chapter). Part II of Form BD-Y2K shall
address each topic in paragraph (e)(5)(iv) of this section as of July
15, 1998.
(B) No later than April 30, 1999, every broker or dealer with a
minimum net capital requirement pursuant to Sec. 240.15c3-1(a)(2) of
$100,000 or greater as of March 15, 1999 shall file Part II of Form BD-
Y2K (Sec. 249.618 of this chapter). In addition, each broker or dealer
subject to paragraph (e)(5)(iii)(A) of this section shall file Part II
of Form BD-Y2K pursuant to this paragraph (e)(5)(iii)(B) regardless of
its minimum net capital requirement. Part II of Form BD-Y2K shall
address each topic in paragraph (e)(5)(iv) of this section as of March
15, 1999.
(C) Every broker or dealer that registers pursuant to section 15 of
the Act between July 15, 1998 and December 31, 1998 or between March
[[Page 37674]]
16, 1999 and October 1, 1999, and that is required to maintain net
capital pursuant to Sec. 240.15c3-1(a)(2) of $100,000 or greater, shall
file Part II of Form BD-Y2K (Sec. 249.18 of this chapter) no later than
30 days after registration becomes effective. Part II of Form BD-Y2K
shall address each topic in paragraph (e)(5)(iv) of this section as of
the effective date of its registration.
(iv) Part II of Form BD-Y2K (Sec. 249.618 of this chapter) prepared
pursuant to paragraph (e)(5)(iii) of this section shall identify a
specific person or persons that are available to discuss the contents
of the report and shall include a discussion of the following:
(A) Whether the board of directors (or similar body) of the broker
or dealer has approved and funded plans for preparing and testing its
computer systems for Year 2000 Problems;
(B) Whether the plans of the broker or dealer exist in writing and
address all mission critical computer systems of the broker or dealer
wherever located throughout the world;
(C) Whether the broker or dealer has assigned existing employees,
hired new employees, or engaged third parties to provide assistance in
addressing Year 2000 Problems, and if so, a description of the work
that these groups of individuals have performed as of the date of each
report;
(D) The current progress of the broker or dealer on each stage of
preparation for potential problems caused by Year 2000 Problems. These
stages are:
(1) Awareness of potential Year 2000 Problems;
(2) Assessment of what steps the broker or dealer must take to
address Year 2000 Problems;
(3) Implementation of the steps needed to address Year 2000
Problems;
(4) Internal testing of software designed to address Year 2000
Problems, including the number and a description of the material
exceptions resulting from such testing that are unresolved as of the
reporting date;
(5) Point-to-point or industry-wide testing of software designed to
address Year 2000 Problems (including testing with other brokers or
dealers, other financial institutions, and customers), including the
number and a description of the material exceptions resulting from such
testing that are unresolved as of the reporting date; and
(6) Implementation of tested software that will address Year 2000
Problems;
(E) Whether the broker or dealer has written contingency plans in
the event, that after December 31, 1999, it has problems caused by Year
2000 Problems;
(F) What levels of management of the broker or dealer are
responsible for addressing potential problems caused by Year 2000
Problems, including a description of the responsibilities for each
level of management regarding the Year 2000 Problems;
(G) Any additional material information concerning its management
of Year 2000 Problems that will help the Commission and the designated
examining authorities assess the readiness of the broker or dealer for
the Year 2000.
(v) The broker or dealer shall file an original and two copies of
Form BD-Y2K (Sec. 249.618 of this chapter) prepared pursuant to
paragraph (e)(5) of this section with the Commission's principal office
in Washington, D.C. and one copy of Form BD-Y2K with the designated
examining authority of the broker or dealer. The reports required by
paragraph (e)(5) of this section shall be public.
* * * * *
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
3. The authority citation for part 249 continues to read in part as
follows:
Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;
* * * * *
4. By adding Sec. 249.618 and Form BD-Y2K to read as follows.
Sec. 249.618 Form BD-Y2K, information required of broker-dealers
pursuant to section 17 of the Securities Exchange Act of 1934 and
Sec. 240.17a-5 of this chapter.
This form shall be used by every broker-dealer required to file
reports under Sec. 240.17a-5(e) of this chapter.
Note: Form BD-Y2K does not appear in the Code of Federal
Regulations. Form BD-Y2K is attached as Appendix A to this document.
By the Commission.
Dated: July 2, 1998.
Margaret H. McFarland,
Deputy Secretary.
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[FR Doc. 98-18292 Filed 7-10-98; 8:45 am]
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