[Federal Register Volume 63, Number 196 (Friday, October 9, 1998)]
[Proposed Rules]
[Pages 54404-54417]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-27120]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-40518; File No. S7-26-98]
RIN 3235-AH04
Books and Records Requirements for Brokers and Dealers Under the
Securities Exchange Act of 1934
AGENCY: Securities and Exchange Commission.
ACTION: Reproposed rule.
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SUMMARY: The Securities and Exchange Commission is reproposing for
comment amendments to its broker-dealer books and records rules, Rule
17a-3 and Rule 17a-4, under the Securities Exchange Act of 1934. The
original proposal was made in 1996 in response to concerns raised by
members of the North American Securities Administrators Association
about the adequacy of the Commission's books and records rules as to
sales practices. The reproposed amendments incorporate comments
received in response to the original proposal. These amendments are
designed to clarify and expand recordkeeping requirements with respect
to purchase and sale documents, customer records, associated person
records, customer complaints, and certain other matters. The reproposed
amendments also specify the books and records that broker-dealers would
have to make available at their local offices. The reproposed books and
records rules are specifically designed to assist securities regulators
when conducting sales practice examinations.
DATES: Comments must be received on or before November 9, 1998.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Mail Stop 6-9, Washington, D.C. 20549. Comments may also be
submitted electronically at the following E-mail address: rule-
[email protected]. All comment letters should refer to File No. S7-26-
98. All comments received will be available for public inspection and
copying in the Commission's Public Reference Room, 450 Fifth Street,
N.W., Washington, D.C. 20549. Electronically
[[Page 54405]]
submitted comment letters will be posted on the Commission's Internet
web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, at (202) 942-0131; Thomas K. McGowan, Assistant Director, at
(202) 942-4886; or Deana A. La Barbera, Attorney, at (202) 942-0734;
Office of Risk Management and Control, Division of Market Regulation,
Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop
10-1, Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION:
I. Introduction
Section 17(a)(1) of the Securities Exchange Act of 1934 (``Exchange
Act'') 1 requires registered broker-dealers to make, keep,
furnish, and disseminate records and reports prescribed by the
Commission ``as necessary or appropriate in the public interest, for
the protection of investors, or otherwise in furtherance of the
purposes of'' the Exchange Act.2 Rules 17a-3 and 17a-4 under
the Exchange Act specify minimum requirements with respect to the
records that broker-dealers must make as well as the periods during
which those records and other documents relating to the broker-dealer's
business must be preserved.3 The Commission, self-regulatory
organizations (``SROs''), and state securities regulators must have
timely access to these records to conduct effective examinations and
enforcement actions.
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\1\ 15 U.S.C. 78a et seq.
\2\ 15 U.S.C. 78q(a)(1).
\3\ 17 CFR 240.17a-3 and 240.17a-4.
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The reproposed recordkeeping requirements are intended to enable
securities regulators to conduct more efficient and effective broker-
dealer examinations primarily for compliance with sales practice
requirements. For situations in which examiners uncover potential
violations of law, the reproposed recordkeeping requirements would
provide regulators with essential tools for enforcement investigations,
and, when necessary, enforcement proceedings. In addition, the
reproposed amendments that would require that records be kept at each
local office of a broker-dealer would improve the ability of securities
regulators, including state securities regulators, to conduct
examinations of sales practice activities of individual offices of a
broker-dealer.
In 1993, the North American Securities Administrators Association
(``NASAA''), through its Broker-Dealer Operations Committee (``NASAA
Committee''), commenced work on a model state regulation that would
require broker-dealers to make and preserve books and records that
would be valuable in examination and enforcement proceedings. The NASAA
Committee presented a final draft of its model regulation for
membership approval at NASAA's October 1995 meeting. At that meeting,
the Commission's Chairman, Arthur Levitt, stated that supplemental
state books and records requirements would impose a substantial burden
on broker-dealers because of the possibility that each state's
requirements would be inconsistent with those adopted by other states
and that modification of the Commission's rules would be a less
burdensome means of accomplishing NASAA's goals. At Chairman Levitt's
request, NASAA's membership voted to defer taking further action with
respect to the NASAA Committee's proposed model regulations to give the
Commission an opportunity to develop appropriate amendments to its
books and records rules.
On October 11, 1996, the National Securities Market Improvement Act
of 1996 (``NSMIA'') was adopted.4 NSMIA prohibited states
from establishing books and records rules that differ from, or are in
addition to the Commission's rules.5 NSMIA also provided
that the Commission must consult periodically with state securities
regulators concerning the adequacy of the Commission's books and
records rules.6
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\4\ Pub. L. 104-290, 110 Stat. 3416 (1996).
\5\ 15 U.S.C. 78o(h).
\6\ Id.
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II. Proposing Release
On October 22, 1996, the Commission proposed amendments
7 to the books and records rules that were designed to
further the Commission's role in protecting investors and to address
the NASAA Committee's concern that the Commission's current books and
records requirements do not obligate broker-dealers to make and retain
records specifically designed to facilitate sales practice examinations
and enforcement activities.
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\7\ Exchange Act Release No. 37850 (Oct. 22, 1996), 61 FR 55593
(Oct. 28, 1996) (``Proposing Release'').
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The amendments to Rule 17a-3 proposed in 1996 would have required
broker-dealers to generate local office blotters, record supplemental
information on brokerage order memoranda, create customer account
forms, and maintain additional records concerning associated persons,
customer complaints, and exceptional activity in customer accounts. The
proposed amendments to Rule 17a-4 would have required broker-dealers to
preserve additional records, including advertising and marketing
materials, registrations and licenses, audit and examination reports,
records concerning recommended securities, and manuals relating to
compliance, supervision, and procedures. Further, the proposed
amendments to Rule 17a-4 would have clarified and modified the
Commission's existing requirements concerning preservation of certain
correspondence and contracts. Finally, the proposed amendments to Rule
17a-4 would have supplemented the existing standards concerning the
organization of books and records, required broker-dealers to designate
a principal to be responsible for books and records compliance, and
required broker-dealers to make certain records available at each of
their local offices.
The Commission received approximately 178 written comments in
response to the Proposing Release. Broker-dealers, trade associations,
and law firms representing broker-dealers submitted 110 comment letters
generally opposing some or all of the proposed amendments. State
securities regulators and NASAA accounted for 33 comment letters
generally supporting the proposed amendments. The balance of the
comment letters were received from other individuals or entities
interested in the Proposing Release.
Most broker-dealers opposed the proposed amendments because they
believed the costs associated with implementing them would outweigh any
increase in investor protection. Many broker-dealer commenters
particularly opposed the proposed amendments requiring certain records
to be kept at each local office and suggested that the records be
maintained at one centralized location with the understanding that the
records would be provided to regulators at a local office on a timely
basis. Some broker-dealers were particularly concerned with the local
office retention requirement because it would apply to one-person
offices. These broker-dealers believed that these offices could be more
effectively supervised if records were held at one centralized
location. Small broker-dealers and those affiliated with insurance
companies suggested that they be exempt from the provisions of the
proposed amendments.
The letters submitted by the state securities regulators and NASAA,
on the other hand, strongly supported the proposed amendments in their
entirety. These commenters believed that the amendments would enable
state securities regulators to conduct more thorough and efficient
broker-dealer
[[Page 54406]]
examinations, particularly of local offices in their respective states.
NASAA commented that state-level examinations have revealed that
broker-dealers, hearing officers, and state courts had divergent
interpretations of the Commission's books and records rules, that state
examinations were often hindered by the absence of key records in local
offices, that many branch records were poorly organized and
inefficiently maintained, and that where records were maintained at a
central location, there often were significant delays in the production
of requested records. These commenters believed the amendments to Rules
17a-3 and 17a-4 would enable state securities regulators to more
effectively conduct broker-dealer examinations, especially examinations
of local branch offices of broker-dealers operating in their respective
states.
III. Reproposed Amendments and Discussion
In response to numerous comments, the Commission is reproposing the
amendments, which have been modified from the original proposal, to
reduce the burden on broker-dealers without substantially detracting
from the original objective of establishing rules that would facilitate
examinations and enforcement activities of the Commission, SROs, and
state securities regulators. Some of the reproposed rules may be
duplicative of SRO recordkeeping rules; 8 nevertheless, the
Commission is reproposing the rules because it believes certain
recordkeeping requirements should be directly enforced by the
Commission and should be available for states to include under their
own laws.
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\8\ For example, the Commission would require broker-dealers to
maintain information, such as investment objectives, about customers
that would overlap certain provisions of National Association of
Securities Dealers (``NASD'') Conduct Rule 3110 and New York Stock
Exchange (``NYSE'') Rule 405.
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A. Memoranda of Brokerage Orders and Dealer Transactions
Rules 17a-3(a)(6) and 17a-3(a)(7) currently require that brokerage
order memoranda and dealer purchase and sale memoranda (``order
tickets'') include information concerning the terms and conditions of
the order, the account for which the order is entered, the time of
entry, the execution price, and to the extent feasible, the time of
execution (or cancellation) of the order.9 The Proposing
Release would have required that each order ticket also identify the
associated person who entered the order and indicate whether the order
was solicited or unsolicited.
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\9\ A number of firms have asked for guidance on the meaning of
the term ``to the extent feasible.'' The time of execution should be
included on the order ticket except for situations in which it may
be impossible to determine the precise time when the transaction was
executed; however, in that case the broker-dealer must note the
approximate time of execution. Exchange Act Release No. 3040 (Oct.
13, 1941), 11 FR 10984.
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As reproposed, an order ticket would still have to identify the
associated person who entered the order, but it would not have to note
whether the transaction was solicited or unsolicited. Further, the
reproposed amendments to Rules 17a-3(a)(6) and (7) would require that
an order ticket contain the identity of any person, other than the
associated person, who entered or accepted the order on behalf of a
customer. This requirement would allow securities examiners to
determine whether particular persons, including unregistered persons,
are engaged in sales practice violations.
The reproposed amendments provide flexibility in how a broker-
dealer would have to record the identity of the person entering the
order. Under the reproposed amendments, if a broker-dealer uses an
electronic system to generate order tickets that does not have a field
available to capture the identity of a person, other than the
associated person, entering an order on a customer's behalf, the
broker-dealer would not have to modify its system to enter that detail
on the order ticket; alternatively, the broker-dealer could create a
separate record identifying the person.
The Commission seeks comment on how this rule should be applied to
firms whose customers use an e-mail address, an electronic trading
system, a general telephone number, or other system or procedure to
submit orders. The Commission also seeks comment on whether certain
firms, such as firms that accept unsolicited orders only or firms that
do not designate a specific associated person for each account, should
be exempt from this rule.
The reproposed amendments also would add a requirement that a
broker-dealer record on the order ticket the time at which the broker-
dealer receives a customer order, even if the order is subsequently
executed. The current rule requires this information only when the
order is not executed. This amendment would enable examiners to review
more easily a broker dealer's compliance with its best execution
obligations and the requirement that a broker-dealer not trade ahead of
its customers.10
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\10\ See 17 CFR 240.11Ac1-1 and 240.11Ac1-4. See also NASD
Conduct Rules 2110 and 2320.
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B. Additional Records Concerning Associated Persons
Rule 17a-3(a)(12) currently specifies the types of records that a
broker-dealer must maintain with respect to each of its associated
persons. In addition to basic background information, the existing rule
requires a broker-dealer to maintain records of each associated
person's employment and disciplinary history. The Proposing Release
would have required that each broker-dealer keep additional records
concerning its associated persons, including registration and licensing
materials, and that certain of these records be kept at each local
office.
The reproposed amendments would not require that Forms U-4 and U-5,
amendments to those forms, or state or SRO licenses be kept at local
offices of the broker-dealer, or that a broker-dealer maintain records
concerning an associated person's change in licensing status. As
several commenters pointed out, this information is readily available
through the Central Registration Depository (``CRD'').
The proposed amendments also would have required that each broker-
dealer maintain records with respect to agreements between associated
persons and the broker-dealer, customer complaint information, and
client trading records for each associated person. The reproposal
largely retains these requirements albeit in new proposed subsections
of the rule.11 These requirements would assist examiners in
reviewing the sales practices of individual associated persons.
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\11\ The requirement regarding customer complaints has been
moved to reproposed Rule 17a-3(a)(17). Other requirements relating
to records for each associated person have been moved to Reproposed
Rule 17a-3(a)(12) so that most of the records required to be kept
about associated persons are located in the same paragraph of Rule
17a-3.
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The reproposed amendments would require that each broker-dealer
maintain a list of any internal identification numbers and CRD numbers
assigned to associated persons and a list of associated persons working
at, out of, or being supervised at or from each local
office.12 This information will assist examiners especially
with respect to conducting an examination of a particular local office.
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\12\ The proposed amendments would have required broker-dealers
to maintain a list identifying the local office where each
associated person conducts the greatest portion of his or her
business. This provision has been discarded in favor of the
reproposed amendments to Rule 17a-3(a)(12).
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Finally, the reproposed amendments would delete the definition of
associated person from Rule 17a-
[[Page 54407]]
3(a)(12)(ii). Given that the term associated person is defined in
several provisions of the Exchange Act, a separate definition under the
rule is unnecessary and potentially confusing.13 Exchange
Act provisions essentially define an associated person to include any
partner, officer, director, or branch manager of a broker-dealer, and
any person occupying a similar status or performing similar functions.
In addition, the term associated person includes any person directly or
indirectly controlling, controlled by, or under common control with a
broker-dealer, or any employee of a broker-dealer. The Commission
interprets the term associated person to include any independent
contractor, consultant, franchisee, or other person providing services
to a broker-dealer equivalent to those services provided by the persons
specifically referenced in the statute.14 Consistent with
this position, the reproposed amendments would require broker-dealers
to keep records regarding all such persons.
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\13\ See Sections 3(a)(18) and (21). See also Sections 3(a)(32)
and 3(a)(45).
\14\ The Commission has taken the position that independent
contractors involved in the sale of securities on behalf of a
broker-dealer (who are not themselves registered as broker-dealers)
must be ``controlled by'' the broker-dealer, and, therefore, are
associated persons of the broker-dealer. See, e.g., In the Matter of
William v. Giordano, 61 S.E.C. Dkt. 345, Exchange Act Release No.
36742 (Jan. 19, 1996)(In finding that an officer of a broker-dealer
firm failed reasonably to supervise an independent contractor, the
Commission found that the independent contractor was an ``associated
person'' of the firm within the meaning of Section 3(a)(18) of the
Exchange Act). See also Letter from SEC Division of Market
Regulation, to Gordon S. Macklin, NASD; Charles J. Henry, CBOE;
Robert J. Birnbaum, AMEX; and John J. Phelan, NYSE, [1982-1983
Transfer Binder] Fed. Sec. L. Rep. (CCH) P77,303 at 78,116 (June 18,
1982); Hollinger v. Titan Capital Corp., 974 F.2d 1564, 1572-76 (9th
Cir. 1990), cert. denied, 111 S. Ct. 1621 (1991). A similar analysis
would be applicable to other persons, such as consultants and
franchisees, performing securities activities with or for the
broker-dealer.
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These records would not be required, however, for persons whose
functions are solely clerical, ministerial, or not directly related to
the securities business. For example, records would need to be retained
for a consultant performing duties equivalent to those of an officer or
a director of a broker-dealer, such as a chief financial officer;
however, no records would be required for a consultant providing
services related to a broker-dealer's health care plan. These records
would be useful in determining whether individuals affiliated with a
broker-dealer are engaged in sales activities and whether individuals
who have been barred from association with broker-dealers are
continuing their association.
C. Customer Account Records
The proposed amendments would have required broker-dealers to
maintain for each customer account an account form that included basic
identification and background information about the customer, including
the customer's investment objectives. The Commission is reproposing
Rule 17a-3(a)(16) with certain modifications to reflect the comments
received regarding the proposed rule.
The reproposed amendments replace the term ``account form'' with
``record of each account of a customer.'' The term was changed in
response to comments that the word ``form'' could be interpreted to
mean paper records only and that many broker-dealers store customer
information electronically.
The reproposed amendments would apply only to accounts that have
natural persons as the beneficial owners. With respect to joint
accounts composed of natural persons, the Commission specifically
solicits comment as to whether the required information should be kept
for each individual participant in a joint account or only for those
individuals with authority to execute transactions in the account.
As proposed, if a customer's investment objectives included
speculation or other high risk objectives, the broker-dealer would have
had to record the percentage of the customer's investment capital
dedicated to such objectives. The proposed rule also would have
required that the portion of the account form regarding the customer's
investment objectives be updated annually. In response to this
proposal, many commenters stated that a customer's investment
objectives can change frequently; thus, a record of specific investment
objectives could quickly become inaccurate. Commenters also stated that
using the phrase ``speculation or similar high-risk objective'' to
categorize a customer's investment objectives would be imprecise. The
reproposed amendments would still require that a customer's investment
objectives or risk tolerance be noted; however, as reproposed, each
broker-dealer would be able to use whatever formulation it chooses to
categorize each customer's investment objectives or risk tolerance.
Further, the reproposed amendments would not require that a customer's
investment objectives be updated annually; rather, as discussed below,
the investment objectives would need to be updated at least once every
36 months. These requirements would allow examiners to more effectively
review for compliance with suitability requirements.
The Proposing Release would have required broker-dealers to furnish
to each customer a copy of the customer's account form within 30 days
of the first trade for the account or within 30 days of a change or
correction to the contents of the account form. The reproposed
amendments modify the original proposal and would require that the
customer account record be furnished to a customer within 30 days of
opening the account and thereafter at least once every 36 months or
when the account record is updated to reflect a change in the
customer's name, address, or investment objectives. This requirement
would provide customers the opportunity to verify and update the
information in their records and correct any misunderstandings or
errors. If the account record is updated to reflect a change of
address, the broker-dealer would have to furnish the account record to
the new address and a notice of the change of address to the old
address. The Commission requests comment on whether a broker-dealer
should include a customer's social security number when sending an
updated account record to the customer.
The neglect, refusal, or inability of a customer to provide or
update any required information for the customer's account record would
excuse the broker-dealer from obtaining the required information.
However, when opening the customer account, the broker-dealer would be
required to make a record of the explanation for the absence of the
information. Although the customer's refusal to provide this
information to the broker-dealer would excuse the firm from obtaining
the information under proposed rule 17a-3(a)(16), the firm would still
be required to comply with any applicable securities regulatory
authority rules regarding obtaining customer information.
For accounts existing on the effective date of the rule, the 36
month period would begin on the effective date of the rule amendment.
If a customer's name, address, or investment objectives do not change
within that 36 month period, the broker-dealer would have to furnish to
the customer a copy of the customer's updated account record no later
than 36 months from the effective date of the amendment. If a
customer's name or address does change during the period, however, the
broker-dealer would have to furnish to the customer a copy of the
customer's updated account record within 30 days of the customer
informing the broker-dealer of the change. In this situation, a new 36
month period would begin on the date
[[Page 54408]]
the updated information is furnished to the customer, provided, the
entire account record is furnished to the customer. Likewise, any other
subsequent change in the customer's name or address also would begin a
new 36 month period.
For an account opened after the effective date of this rule
amendment, the broker-dealer would be required to send an account
record within 30 days of the opening of the account. Thereafter, the 36
month period would begin on the date the account is opened.
Additionally, a new 36 month period would begin any time a broker-
dealer furnishes a complete updated account record to a customer.
Broker-dealers would be free, of course, to update account record
information more frequently than the rule requires.
Reproposed Rule 17a-3(a)(16) would add a requirement that
information be kept as to whether the customer is an associated person
of a broker-dealer. If an account is a discretionary account, the
record would have to contain the dated signature of each customer
granting the discretionary authority over the account and the dated
signature of each person to whom discretionary authority was granted.
These requirements would assist examiners in identifying possible
trading or sales practice violations, such as churning, trading ahead
of customers, front-running, or possible manipulative activities
involving controlled or nominee accounts.
The reproposed amendments would also require a broker-dealer to
create a record indicating whether it has complied with applicable
securities regulatory authority rules governing the information
required when opening or updating a customer account.15 This
provision, for example, would apply to Exchange Act Rule 15g-9 which
requires broker-dealers to follow certain procedures before effecting
customer transactions in the penny stock market, Municipal Securities
Rulemaking Board Rule G-8(a)(xi) which requires broker-dealers and
municipal securities dealers to obtain certain customer information
before effecting transactions in municipal securities, NASD Rule 3110
which requires broker-dealers to maintain certain customer account
information, such as a customer's address and residence, NASD Rule
2860(b)(16) regarding the opening of options accounts, NASD Rule 2310
regarding information that must be obtained prior to making investment
recommendations to customers, NYSE Rule 405 which requires NYSE members
to use due diligence to learn the essential facts relative to every
customer, and Chicago Board of Options Exchange Rule 9.7 which sets
forth the requirements for opening a customer options account. This
requirement would help the Commission staff and state securities
regulators in reviewing for compliance with securities regulatory
authority rules relating to customer information and sales practice
violations. The Commission requests comment on whether there are other
SRO or Commission rules relating to opening or updating customer
accounts that would or should be included under this proposed
recordkeeping requirement. Because many broker-dealers likely already
keep such records, would this requirement impose any additional burden
on broker-dealers? Are there any alternatives that would be less
burdensome?
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\15\ Reproposed Rule 17a-3(a)(16)(ii).
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D. Customer Complaints
The Proposing Release would have required broker-dealers to
maintain files of written materials relating to customer complaints and
to make and keep written memoranda of oral customer complaints alleging
certain types of fraud and theft. The reproposed amendments would not
require broker-dealers to document oral complaints or require each
local office to maintain a customer complaint file of all
correspondence, memoranda, and other documents received in connection
with the complaint. Instead, each broker-dealer would have to keep a
record of written complaints against each associated
person.16 In addition, a broker-dealer would have to
maintain for each local office a record of written complaints against
each associated person that conducts business at that local
office.17 The records would have to include, among other
things, a description of the nature of the complaint, the name of the
complainant, and the disposition of the complaint. As an alternative to
maintaining a record of each customer complaint, a broker-dealer may
keep a copy of the written complaint along with a record of the
disposition of the complaint. These complaint retention requirements
would enable examiners to detect patterns of customer abuses, both
within particular offices and firm wide.
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\16\ Reproposed Rule 17a-3(a)(17).
\17\ See Reproposed Rule 17a-3(f).
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Reproposed Rule 17a-3(a)(17)(ii) would require that broker-dealers
create a record indicating that each customer has been notified of the
address and telephone number of the department of the broker-dealer to
which any complaints may be directed. This requirement would expand on
an existing interpretation of the Commission's financial responsibility
rules and the Securities Investor Protection Act of 1970, which states
that, for purposes of custody of securities, for a broker-dealer to
qualify as an introducing firm, its customers must be treated as
customers of the clearing firm.18 Furthermore, under that
interpretation, the clearing firm must issue account statements
directly to customers and each account statement must contain the name,
address, and telephone number of a responsible individual at the
clearing firm whom a customer can contact with inquiries and complaints
regarding the customer's account. This reproposed requirement would
apply to all firms carrying or clearing customer accounts in addition
to those firms in an introducing/clearing arrangement.
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\18\ Exchange Act Release No. 31511 (Nov. 24, 1992), 57 FR 56973
(Dec. 2, 1992).
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E. Other Required Records
The Proposing Release would have required broker-dealers to create
commission and compensation records for each associated person. The
reproposed amendments would require essentially the same information as
originally proposed, but would allow broker-dealers greater flexibility
in how they can retain the records.19 For example, in lieu
of retaining the individual compensation records, broker-dealers would
be permitted to store electronically the data necessary to produce the
records.20 Broker-dealers that choose this option would be
required to produce the records upon request. Additionally, the
reproposed amendments would clarify that records must be kept for non-
monetary as well as monetary compensation. This would assist examiners
in detecting sales practice violations tied to a firm's compensation
practices.
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\19\ Reproposed Rule 17a-3(a)(18).
\20\ See Reproposed Rule 17a-3(f).
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The Proposing Release would have required broker-dealers to produce
reports to monitor unusual occurrences in customer accounts such as
frequent trading, unusually high commissions, or an unusually high
number of trade corrections or cancellations. The reproposed amendments
would not require broker-dealers to make these types of reports, but
instead, would require broker-dealers to retain these reports, if
created, or be able to recreate them upon request.21 Because
this provision would now be a record
[[Page 54409]]
retention requirement, it has been moved to Rule 17a-4. These
requirements would assist examiners in identifying violations such as
churning and unauthorized trading. The Commission requests comment on
whether the requirement that these reports be kept for three years is
appropriate.
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\21\ Reproposed Rule 17a-4(b)(11).
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F. Local Office
The definition of a local office is significant because broker-
dealers must create records regarding activities in each local office
and maintain a copy of certain records at that local office. This
section discusses the reproposed definition of local office, the
records that would be required to be maintained at each local office,
alternative means of record retention for local offices, and state
record depositories for those offices that do not qualify as local
offices.
1. Definition of Local Office
The reproposed amendments would modify the definition of ``local
office'' to include locations where two or more associated persons
regularly conduct a securities business.22 This definition
has been modified from the Proposing Release, which would have included
one-person offices in the definition, primarily in response to comments
from broker-dealers that have many one-person offices or have
associated persons who work from their homes. In these instances,
records currently are stored at centralized locations maintained by the
broker-dealers. Commenters stated that requiring records to be
maintained at a one-person office or at an associated person's home
would be extremely burdensome and could interfere with a broker-
dealer's supervisory duties. By reproposing the definition of local
office to include an office with two or more associated persons, the
Commission has attempted to eliminate those situations in which a
broker-dealer has minimal presence at a particular location, such as
one associated person at a bank branch, while still providing
securities regulatory authorities with local access to office records
of a broker-dealer.
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\22\ Reproposed Rule 17a-3(g)(1).
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The Commission requests comment on whether, and if so, how many and
why, a higher number of associated persons would be appropriate for the
definition of local office. The Commission requests commenters to
provide, if applicable, information on the number of offices in each
state that would fall within the reproposed definition of a local
office, the number of offices that would fall within the definition
suggested by the commenter, and the total number of offices for that
broker-dealer firm. Commenters also should specify what percentage of
the firm's business is conducted at the local offices as defined under
the reproposed amendments and under any alternative definitions
suggested by the commenter.
2. Local Office Records
The reproposed amendments would require broker-dealers to make and
keep separately for each local office records including blotters,
broker and dealer order tickets, customer account records, customer
complaints, evidence of compliance with securities regulatory authority
rules, a list of state record depositories, names of persons capable of
explaining the records, and names of any principals responsible for
establishing policies and procedures, and records relating to the
associated persons at each local office including employment
agreements, identification numbers, compensation agreements, sales
records relating to associated person compensation, and chronological
sales records.23 Keeping these records regarding each local
office would assist securities regulators by enabling them to conduct
focused localized examinations of particular offices and identify
abusive activities that may be isolated to that office.
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\23\ Reproposed Rule 17a-3(f).
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3. Record Retention at Local Offices
The reproposed amendments would require broker-dealers to make
available at the respective local office certain records, including
blotters of the local office's activities, memoranda of brokerage
orders and dealer transactions, customer account records, customer
complaints, and associated person records (collectively ``Local Office
Records'').24 The Commission is now proposing that Local
Office Records be kept at the local office for the most recent one year
period. Requiring a year's worth of Local Office Records at the local
office should provide securities regulators with sufficient records to
conduct examinations of local offices while not imposing unnecessary
burdens on broker-dealers. After a year, broker-dealers would still be
required to keep Local Office Records at their headquarters office or
some other centralized location, subject to the accessibility
requirements of Rules 17a-4(a) and (b).
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\24\ Reproposed Rule 17a-4(k).
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The Commission is seeking comment on whether state securities
regulators should have authority to waive the requirement that a
broker-dealer keep Local Office Records at local offices within their
respective states. The Commission also seeks comment on whether the
reproposed record retention period of one year for local offices is
appropriate.
4. Alternative Means of Record Retention
The Commission recognizes that some broker-dealers have
recordkeeping systems that are more technologically advanced than
others. These systems should enable broker-dealers to provide
securities regulators with records at a local office in a timely manner
without actually keeping the records at a local office. Therefore, the
Commission is proposing an alternative means for satisfying the local
office recordkeeping requirements. A broker-dealer's capability to
produce printed copies of Local Office Records in a local office the
same day the request for the records is made, or within a reasonable
time under certain unusual circumstances, would satisfy the local
office recordkeeping requirements.25 By proposing an unusual
circumstance exception, the Commission is addressing situations in
which the broker-dealer has made a good faith effort to produce the
records, but meets an unexpected delay in the production of the
records. For example, the broker-dealer may experience a computer
communication failure that cannot be immediately rectified by a local
office. In contrast, the absence of a person authorized by the broker-
dealer to deliver the records would not be an acceptable reason for
delaying delivery of the requested records.
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\25\ Reproposed Rule 17a-4(k)(1).
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5. Promptly Furnishing Records at Local Offices
As proposed, the definition of the term ``promptly'' would have
specified that requested records must be produced immediately for
records located in the office where a request is made and within three
business days for records that are not located in the office. These
amendments were proposed so that securities regulators would have
prompt access to records while they were conducting examinations at
local offices. The reproposed amendments have been modified to reduce
the burden that the proposed amendments would have placed on broker-
dealers by allowing broker-dealers to use the alternative means of
record retention discussed above.26
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\26\ Id.
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[[Page 54410]]
G. State Record Depositories for Offices Not Meeting the Local Office
Definition
The reproposed rules modify the proposed definition of local office
to include offices with two or more associated persons. As to offices
with only one associated person, the Commission is reproposing that
those records may be stored at a state record depository. The state
record depository would have to be located in the same state in which
the office (or offices) not meeting the definition of local office is
located. Further, with respect to an associated person who works out of
more than one office, a state record depository would have to be
located in each state in which the associated person conducts business.
The Commission recognizes that this may place an additional burden on
some broker-dealers; however, the Commission believes that to support
examinations by state securities regulators, these associated person
records must be available in the state in which that person is active.
The Commission requests comment on whether, to what extent, and under
what circumstances a state should be permitted to waive the state
record depository requirement for broker-dealers conducting business in
its state.
H. Records Regarding Approval of Communications
The proposed amendments would have required a record be kept
indicating whether outgoing communications had been approved by a
principal. The reproposed amendments modify that proposal to require
that a broker-dealer retain any written approvals of outgoing
communications sent and any written procedures it uses for reviewing
outgoing communications. This change reflects the recent amendments to
SRO rules which permit member firms to establish reasonable procedures
for reviewing a registered representative's communications with the
public.27 The Commission also is proposing to add a
requirement that broker-dealers maintain a record of any written
procedures for reviewing marketing materials and a record listing each
principal of a broker-dealer responsible for establishing policies and
procedures to ensure compliance with applicable regulations of a
securities regulatory authority that require approval of a record by a
principal.28 These requirements are designed to allow easier
examination for sales practice abuses, such as unauthorized trading,
suitability, churning, and other misrepresentations.
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\27\ See Exchange Act Release No. 39510 (Dec. 31, 1997), 63 FR
1131 (Jan. 8, 1998) and Exchange Act Release No. 39511 (Dec. 31,
1997), 63 FR 1135 (Jan. 8, 1998).
\28\ Reproposed Rule 17a-4(b)(10).
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I. Audit and Examination Reports
The proposed amendments would have required broker-dealers to keep
for at least three years all audit or examination reports prepared by a
person other than the broker-dealer. Several commenters stated that
this requirement is not warranted because it might discourage self-
critical evaluations of a firm's business, particularly if the firm
would be required to share the report with regulators that may not have
authority to protect the confidentiality of the reports. In light of
this, the Commission is reproposing the requirement that each broker-
dealer keep for three years all reports requested or required by a
securities regulatory authority and any securities regulatory authority
examination reports.29 This requirement would help avoid
unnecessary duplication in examinations. The Commission requests
comment on whether there are any reasons why broker-dealers should not
be required to keep such reports (for example, confidentiality concerns
arising from particular state law requirements).
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\29\ Reproposed Rule 17a-4(e)(5).
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J. Technical Amendments
On February 5, 1997, the Commission amended Rule 17a-4 to allow
broker-dealers to employ, under certain conditions, electronic storage
media to maintain its records.30 The Commission is now
proposing technical amendments to that rule.31 The
Electronic Storage Media Release provided that a broker-dealer that
employs micrographic or electronic storage media must be ready at all
times to immediately provide a facsimile enlargement upon request by
the Commission or its representatives.32 It also provided
that for a broker-dealer that uses electronic storage media, a third
party download provider must file undertakings with that broker-
dealer's designated examining authority indicating that it will furnish
promptly to the Commission, its designees or representatives, the
information necessary to download information kept on a broker-dealer's
electronic storage media.33 Because SROs and state
securities regulators are neither representatives nor designees of the
Commission but, to the extent that they have jurisdiction over the
broker-dealer serviced by the third party download provider, are
organizations that should have access to facsimile enlargements and
download information, the Commission is proposing technical amendments
to provide them with access to these records.
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\30\ Exchange Act Release No. 38245 (Feb. 5, 1997), 62 FR 6469
(Feb. 12, 1997) (``Electronic Storage Media Release'').
\31\ Rule 17a-4(f).
\32\ See Rule 17a-4(f)(3)(i).
\33\ See Rule 17a-4(f)(3)(vii).
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IV. General Request for Comments
The Commission invites interested persons to submit written
comments on all the reproposed amendments. Also, the Commission
specifically requests comments concerning the definition of local
office; the one year record retention period for local office records;
and the retention and production of external audit, examination, and
consulting reports.
The Commission requests comment regarding whether there are
alternative books and records requirements that would facilitate
examination of local offices and review of sales and trading practices.
Are there any other records, in addition to compensation records, that
the Commission should require broker-dealers to retain that would show
sales incentives?
Is it necessary for Commission rules to also provide for state
regulator access to books and records? Are there other measures the
Commission could undertake to promote cooperation and coordination with
state securities regulators regarding examinations and enforcement
actions regarding broker-dealers? Are there alternatives to the local
office requirements that would similarly expedite examinations away
from a broker-dealer's home office?
With respect to the proposed requirement that broker-dealers be
able to demonstrate compliance with certain SRO and state securities
regulatory requirements, is there an alternative way for securities
regulators to obtain this information? Are there other types of records
that would contain information that securities regulators may use to
identify potential regulatory concerns?
V. Effects on Efficiency, Competition, and Capital Formation
Section 23(a) of the Exchange Act requires the Commission, in
adopting rules under the Exchange Act, to consider any impact on
competition and to not adopt a rule that would impose a burden on
competition not necessary or appropriate in furtherance of the
Act.34 Pursuant to Section 3(f) of the Exchange Act, when
the Commission
[[Page 54411]]
considers whether an action is necessary or appropriate in the public
interest, the Commission considers whether the action will promote
efficiency, competition, and capital formation, in addition to the
protection of investors. The Commission is considering the reproposed
amendments to Rules 17a-3 and 17a-4 in light of these standards, and
the Commission believes that any burden imposed by the reproposed
amendments should be justified by the enhanced investor protection
described above. In addition, by improving examination capabilities,
the reproposed amendments should improve investor confidence in broker-
dealer firms and help maintain fair and orderly markets. The
requirements would apply to all broker-dealers that conduct business
with the general public. Larger broker-dealers would have
correspondingly greater obligations under the amendments. Accordingly,
any burden on broker-dealer competition should be slight, especially in
light of the significant regulatory benefits and investor protection
purposes discussed above. The Commission solicits comment on any effect
on efficiency, competition, or capital formation the reproposed
amendments may have.
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\34\ See 15 U.S.C. 78w(a)(2).
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VI. Costs and Benefits of the Proposed Amendments and Their Effects
on Competition
To assist the Commission in its evaluation of the costs and
benefits that may result from the reproposed amendments to Rules 17a-3
and 17a-4, commenters are requested to provide information relating to
costs and benefits associated with any of the proposals herein.
The requirements of reproposed rules 17a-3 and 17a-4 are discussed
together rather than separately because the underlying purposes for
both making and keeping the reproposed records are so closely related.
However, because the Commission requests specific comment on the costs
and benefits, including specific estimates of hour and dollar burdens
that may result from these reproposed amendments, commenters may wish
to discuss each rule and the subparts of each rule individually.
A. Benefits
The reproposed amendments should result in increased efficiency and
effectiveness of broker-dealer examinations especially with respect to
local offices. The enhanced recordkeeping requirements would also
provide critical information necessary for securities regulatory
authorities to discover and take appropriate action for various
securities violations, particularly, sales practice violations.
Generally, the reproposed amendments would require additional
information in four main areas including (1) customer information, (2)
associated person information, (3) transaction information (i.e.,
purchases and sales), and (4) local office information. The reproposed
rules relating to additional customer information (i.e., the account
record) would provide a clear and relatively current record of customer
information, including a customer's financial profile and investment
objectives. This record would provide securities regulators with
information to enable them to determine whether transactions in
particular securities were suitable for a customer.
The reproposed amendments relating to associated person information
can be further broken down into two categories including compensation
records and complaint records organized according to associated person.
First, the compensation records would help provide securities
regulators with insight into why associated persons may have conducted
certain transactions. For example, the compensation records would allow
securities regulators to determine whether financial or other
incentives existed that may have led an associated person to engage in
excessive transactions. Second, the complaint records organized
according to registered representative would allow securities
regulators to determine whether an associated person has engaged or is
continuing to engage in certain securities violations such as sales
practice abuses.
The reproposed amendments relating to transactions would require
broker-dealers to include on order tickets, among other things, the
time the order was received, the identity of the associated person
responsible for the account, and the identity of any other person who
accepted or entered the order. First, the requirement that an order
ticket note the time the order was received would allow securities
regulators to determine whether the broker-dealer executed the
transaction in a timely manner and in compliance with applicable
regulations. Second, indicating on the order ticket the identity of the
associated person responsible for the account as well as the identity
of any other person who entered or accepted the order would provide
securities regulators with insight into a variety of abusive
activities. For example, securities regulators would be better able to
identify situations in which a person who was barred from the industry
was, nevertheless, continuing to associate with a broker-dealer by
entering orders under another person's name. Additionally, the records
could help reveal that a broker-dealer was engaging in boiler room
activities in situations in which numerous associated persons were
accepting and entering orders under one associated person's name.
With respect to local office information, the requirement that
certain records be kept for each local office would allow securities
regulators to conduct a focused localized exam of a particular office
and identify abusive activities that may be isolated to that office.
Further, requiring broker-dealers to store certain records at local
offices would allow securities regulators to conduct more effective and
thorough examinations because they would be able to conduct the
examinations on-site where they could review the pertinent records and
interview various employees regarding the contents of those records.
Additionally, making the records available at the local office is
important to reduce the potential for alteration or fabrication of
records when requested. Finally, requiring broker-dealers to maintain
or make available particular records at local offices would help
facilitate examinations by state securities regulators because the
records would be located within that regulator's jurisdiction.
B. Costs
Many of the records required under the reproposed amendments
already are required under SRO rules, thus, tempering the impact of the
reproposed amendments on broker-dealers. However, the Commission
recognizes that compliance with the reproposed rules may require
broker-dealers to make certain adjustments to their current systems and
methods of record creation and storage.
The Commission believes that the bulk of the additional costs of
the reproposed amendments would result from three areas: (1) the
requirement that account records be updated; (2) the requirement that
certain records regarding local offices be made; and (3) the
requirement that records be stored at or made available at local
offices or state record depositories.35 Accordingly, the
Commission has included certain provisions in the reproposed amendments
that should lessen the impact on broker-dealers. For example, rather
than storing hard copies of certain records, local offices may use a
[[Page 54412]]
system, which could range from ordinary E-Mail to a Local Area Network
system to an intranet system, capable of producing printed copies of
the records at the local office. The Commission believes that many
broker-dealers already have in place systems that are capable of
transmitting the information between offices immediately or on the same
business day. This provision should provide securities regulators with
timely access to records without requiring broker-dealers to actually
produce and store in hard copy format every record required under the
reproposed rules. The Commission seeks comment on alternative systems
or methods of storing records or providing local offices and state
record depositories with timely access to records.
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\35\ The Paperwork Reduction Act section of this release
contains additional information relating to costs.
---------------------------------------------------------------------------
In some instances, the reproposed amendments provide that broker-
dealers may choose between alternative methods of recordkeeping. For
example, the reproposed amendments relating to the contents of an order
ticket would add the requirement that order tickets contain, among
other things, the identity of each associated person and any other
person who entered or accepted the order. However, if the broker-
dealer's system is incapable of receiving an entry for any other person
or if the alteration to the system would be costly, the broker-dealer
would not have to alter its system; rather, the broker-dealer may make
a separate record of the additional persons who enter or accept orders.
VII. Summary of Initial Regulatory Flexibility Analysis
In accordance with 5 U.S.C. 603, the Commission has prepared an
Initial Regulatory Flexibility Analysis (``IRFA'') concerning the
reproposed amendments. The IRFA notes that the purpose of the
reproposed amendments is to enhance the ability of securities
regulators to protect investors through more effective and efficient
examinations and enforcement proceedings. The Commission believes that
the reproposed amendments are necessary to ensure that registered
broker-dealers keep books and records that are sufficient to permit
securities regulators to conduct complete sales practice and
operational examinations. The IRFA further states that the reproposed
amendments would affect all broker-dealers, including the approximately
1,389 small broker-dealers, but notes that the requirements of the
reproposed amendments were designed to minimize additional burdens. It
also states that the reproposed amendments may require broker-dealers
to adjust their record making and keeping practices and to update
certain customer information records every 36 months. The IRFA states
that no federal securities laws duplicate, overlap, or conflict with
the reproposed amendments and that the Commission does not believe that
any less burdensome alternatives are available to accomplish the
objectives of the reproposed amendments.
The Commission encourages the submission of written comments with
respect to any aspect of the IRFA. If the reproposed amendments are
adopted, written comments will be considered in preparation of the
Final Regulatory Flexibility Analysis. Comments will be placed in the
same public file as that designated for the reproposed amendments. A
copy of the IRFA may be obtained by contacting Deana A. La Barbera,
Division of Market Regulation, Securities and Exchange Commission, 450
Fifth Street, N.W., Mail Stop 10-1, Washington, D.C. 20549, (202) 942-
0734.
VIII. Paperwork Reduction Act
Certain provisions of the reproposed amendments contain
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995.36 The Commission has
submitted the reproposed amendments to the Office of Management and
Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5
CFR 1320.11 under the title ``Reproposed Books and Records
Amendments.''
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\36\ 44 U.S.C. 3501 et seq.
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A. Collection of Information Under Reproposed Books and Records
Amendments
As discussed previously in this release, the Reproposed Books and
Records Amendments would require registered broker-dealers to maintain
additional records with respect to purchase and sale documents,
customer information, associated person information, customer
complaints, and certain other matters.
B. Proposed Use of Information
The information collected pursuant to the Reproposed Books and
Records Amendments would be used by the Commission, self-regulatory
organizations, and other securities regulatory authorities for
examinations and enforcement proceedings regarding broker-dealers and
associated persons. No governmental agency would regularly receive any
of the information described above. Instead, the information would be
stored by the registered broker-dealer and made available to the
various securities regulatory authorities for examinations and
enforcement proceedings. To comply with the reproposed amendments that
require broker-dealers to update customer account records at least
every 36 months, broker-dealers would have to furnish their customers
with a copy of the account record. This requirement and the estimated
burden associated with it are discussed in detail in section D below.
C. Respondents
The Reproposed Books and Records Amendments would apply to all the
approximately 7,769 active broker-dealers 37 that are
registered with the Commission. Most of the provisions of the
Reproposed Books and Records Amendments would apply only to the
approximately 5,400 broker-dealers that conduct business with the
general public; this is because most of the provisions relate to a
broker-dealer's and its associated persons' dealings with customers
(e.g., the requirement that broker-dealers update customer account
records).
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\37\ Of approximately 8,500 broker-dealers registered with the
Commission, approximately 450 are not yet active because their
registration is pending SRO approval and approximately 300 are
inactive because they have ceased doing a securities business and
have filed a Form BDW with the Commission.
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D. Total Annual Reporting and Recordkeeping Burden
The hour burden of the Reproposed Books and Records Amendments
would vary widely because of differences in the levels of activities of
the respondents and because of differences in the current recordkeeping
systems of the respondents. Therefore, the estimates in this section
are based on averages among the various types and sizes of broker-
dealer firms. Most of the requirements of the Reproposed Books and
Records Amendments involve collections of information that typical
broker-dealers already maintain under customary and usual business
practices or in compliance with SRO rules.
The reproposed amendments modify Rule 17a-3 by, among other things,
requiring broker-dealers to update customer account records at least
every 36 months. Broker-dealers currently maintain approximately
60,000,000 customer accounts. Because the account records must be
updated at least once every 36 months, the Commission estimates that,
on average, the account records of one-third of the total accounts
(i.e. 20,000,000) would have to be updated each year. To comply with
this
[[Page 54413]]
requirement, broker-dealers would have to furnish customers with the
existing account record and request that the customer make any
necessary changes. However, the Commission believes that not every
account record will be changed in response to the broker-dealer's
request for updated information because the account record may still be
current or the customer may elect not to respond. The Commission
estimates that approximately 10% of the requests for updated
information will result in changes to the record resulting in 2,000,000
(10% of \1/3\ of total customer accounts) updated account records each
year. The Commission estimates that it will take, on average, 10
seconds to furnish the account record to each customer. The Commission
further estimates that it will take, on average, five minutes for a
broker-dealer to update each account record. This estimate takes into
account the amount of time it would take to receive the returned data
and input any changes into the account record. Additionally, this time
estimate takes into account that certain SRO rules already require
broker-dealers to maintain current information about their customers
and that broker-dealers maintain current account record information in
the ordinary course of business.
Therefore, the Commission estimates that the requirement that
broker-dealers update account records would require approximately
222,223 hours each year; this is derived from 55,556 hours to furnish
the account records to customers (20,000,000 account records x 10
seconds / 60 seconds / 60 minutes) plus 166,667 hours each year to
receive and input the updated information (2,000,000 account records
x 5 minutes / 60 minutes)38
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\38\ The Commission staff estimates that the approximate
administrative and labor costs to broker-dealers to comply with this
requirement would be $25 per hour (based on an annual salary of
$52,000) resulting in a total annual cost of $5,555,575 (based on
$25 per hour multiplied by 222,223 burden hours). This estimate does
not include any systems costs.
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In addition to the account record updating requirement, the
Reproposed Books and Records Rules would require broker-dealers to keep
certain records regarding their associated persons, including
agreements pertaining to the associated person's relationship with the
broker-dealer, compensation arrangements, identification numbers, the
office at which each associated person's records are
stored,39 each associated person's compensation for each
transaction,40 and a chronological sales
record.41 With the exception of the compensation record and
chronological sales record, the records are the type of records that
would be updated infrequently. Additionally, the Commission believes
that all these records are the type of records that broker-dealers
would keep in the ordinary course of business. Therefore, the
Commission estimates that, on average, these records would require a
broker-dealer to spend approximately 30 minutes each year to ensure
that it is in compliance with the reproposed amendments.
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\39\ Reproposed Rule 17a-3(a)(12).
\40\ Reproposed Rule 17a-3(a)(18).
\41\ Reproposed Rule 17a-3(a)(20).
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The reproposed amendments also would require broker-dealers to make
records which indicate that they have complied with any applicable
regulations of securities regulatory authorities,42 and
which list persons who can explain the information in the broker-
dealer's records,43 each principal responsible for
establishing compliance policies and procedures,44 and each
office designated as a state record depository.45 The
Commission believes that the information required under each of these
rules would be readily available to broker-dealers and is the type of
information that would change infrequently. Therefore, the Commission
estimates that, on average, a broker-dealer would spend approximately
10 minutes each year to ensure that it is in compliance with these
requirements.
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\42\ Reproposed Rule 17a-3(a)(19).
\43\ Reproposed Rule 17a-3(a)(21).
\44\ Reproposed Rule 17a-3(a)(22).
\45\ Reproposed Rule 17a-3(a)(23).
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The reproposed amendments also would require that broker-dealers
keep a record of customer complaints.46 Broker-dealers
already are required to keep this information under existing SRO rules;
however, under the reproposed rules, the record must be made available
at the local office or state record depository. The Commission believes
that because broker-dealers already maintain these records, any
additional burden resulting from this requirement would be nominal.
Therefore, the Commission estimates that, on average, the burden would
be 20 minutes per broker-dealer each year to ensure that it is in
compliance with this rule.
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\46\ Reproposed Rule 17a-3(a)(17).
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The reproposed amendments relating to order tickets would require
that broker-dealers note the time the order was received and the name
of any person other than the associated person responsible for the
account who accepted or executed the order.47 The Commission
believes that, in the ordinary course of business, most broker-dealers
already note on the order ticket the time the order was received;
therefore, this requirement would not impose an additional burden on
broker-dealers.
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\47\ Reproposed Rules 17a-3(a)(6) and (a)(7).
---------------------------------------------------------------------------
The degree of the burden imposed by the requirement that any
additional person be noted on the order ticket depends largely upon the
business practices of the individual firms and their current
recordkeeping systems; therefore, it is difficult for the Commission to
provide an accurate estimate of the burden associated with this
requirement. The Commission believes, however, that any additional
burden would be nominal because the requirement may be satisfied by a
minor notation on the order ticket or on a separate record.
In total, the Commission estimates that compliance with the
Reproposed Books and Records Rules for Rule 17a-3 would require an
additional 229,992 hours per year ((222,223 hours (annualized account
record updating) + 7,769 hours 48 (one hour per broker-
dealer each year for the balance of the additional rules)). Therefore,
the current OMB inventory of 1,941,062 hours for Rule 17a-3 would
increase by 229,992 hours to 2,171,054 hours.
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\48\ The Commission staff estimates that the approximate cost to
broker-dealers to comply with this requirement would be $48.08 per
hour (based on an annual salary of $100,000) including the value of
professional staff compensation and related overhead resulting in a
total annual cost of $373,534 (based on $48.08 per hour multiplied
by 7,769 burden hours). This estimate does not include any systems
costs.
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The Reproposed Books and Records Rules would modify Rule 17a-4 by
requiring broker-dealers to maintain additional books and records,
including materials used by a broker-dealer to offer or sell
securities, copies of reports produced to review activity in customer
accounts, and a record listing all persons who are qualified to explain
a broker-dealer's books and records. The reproposed amendments to Rule
17a-4 also would require broker-dealers to make available certain
records at the local offices or state record depositories. The
reproposed amendments provide that broker-dealers may retain the
records in a system capable of producing the records upon request,
which should minimize additional record retention burdens on broker-
dealers. Also, as discussed above, most of the additional records
already are maintained by the broker-dealers; therefore, the majority
of the additional burden would result from the requirement that broker-
dealers retain
[[Page 54414]]
records at local offices or state record depositories.
Based on the information above, the Commission estimates that, on
average, each broker-dealer would spend one business day each year to
ensure that it is in compliance with the reproposed amendments to Rule
17a-4 and to ensure that the records are available at local offices and
state record depositories. Therefore, the current OMB inventory for
Rule 17a-4 of 2,127,125 hours would be increased by 62,152 hours (7,769
active broker-dealers x 8 hours) resulting in a total of 2,189,277
hours.49
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\49\ The Commission staff estimates that the approximate
professional labor costs to the broker-dealer industry to comply
with this requirement would be $48.08 per hour (based on an annual
salary of $100,000) resulting annual cost of $2,988,268 (based on
$48.08 per hour multiplied by 62,152 burden hours). This estimate
does not include any systems costs.
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E. General Information About the Collection of Information
The collection of information under the Reproposed Books and
Records Amendments would be mandatory. The information collected
pursuant to Rules 17a-3(a)(17), (21), (22), and (23) would be retained
for six years. The information collected pursuant to Rules 17a-
3(a)(18), (19), and (20), 17a-4(b) (4), (7), (10), and (11), and 17a-
4(e)(5) would be retained for three years. The information collected
pursuant to Rule 17a-3(a)(16) would be retained for six years after the
closing of the related customer's account. The information collected
pursuant to Rule 17a-4(d) would be retained for the life of the
enterprise or any successor enterprise. The information collected
pursuant to Rule 17a-3(a)(20) would be retained for three years. The
information collected pursuant to Rule 17a-4(e)(6) would be retained
for three years after the date of the termination of use of the
information. In general, the information collected pursuant to the
Reproposed Books and Records Amendments would be held by the
respondent. The Commission, self-regulatory organizations, and other
securities regulatory authorities would only gain possession of the
information upon request. Any information received by the Commission
pursuant to the Reproposed Books and Records Amendments would be kept
confidential, subject to the provisions of the Freedom of Information
Act, 5 U.S.C. 552.
F. Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
(i) Evaluate whether the proposed collection of information is
necessary for the proposed performance of the functions of the
Commission, including whether the information shall have practical
utility;
(ii) Evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information;
(iii) Enhance the quality, utility, and clarity of the information
to be collected; and
(iv) minimize the burden of the collection of information on those
required to respond, including through the use of automated collection
techniques or other forms of information technology.
Persons desiring to submit comments on the collection of
information requirements should direct them to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
D.C. 20503, and should also send a copy of their comments to Jonathan
G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth
Street, N.W., Mail Stop 6-2, Washington, D.C. 20549, and refer to File
No. S7-26-98. OMB is required to make a decision concerning the
collections of information between 30 and 60 days after publication of
this release in the Federal Register, therefore, comments to OMB are
best assured of having full effect if OMB receives them within 30 days
of this publication.
IX. Statutory Analysis
The amendments are proposed pursuant to the authority conferred on
the Commission by the Exchange Act, including Sections 17(a) and 23(a).
List of Subjects in 17 CFR Part 240
Brokers, Reporting and recordkeeping requirements, Securities.
For the reasons set forth in the preamble, Title 17 Chapter II of
the Code of Federal Regulation is proposed to be 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. Section 240.17a-3 is amended by revising paragraphs (a)(6),
(a)(7), and (a)(12)(ii), and adding paragraphs (a)(12)(iii),
(a)(12)(iv), (a)(12)(v), (a)(16), (a)(17), (a)(18), (a)(19), (a)(20),
(a)(21), (a)(22), (a)(23), (f) and (g) to read as follows:
Sec. 240.17a-3 Records to be made by certain exchange members, brokers
and dealers.
(a) * * *
(6) A memorandum of each brokerage order, and of any other
instruction, given or received for the purchase or sale of securities,
whether executed or unexecuted. The memorandum shall show the terms and
conditions of the order or instructions and of any modification or
cancellation thereof; the account for which entered; the time the order
was received; the time of entry; the price at which executed; the time
of execution or cancellation, to the extent feasible; and, except as
otherwise provided in this paragraph, the identity of each associated
person responsible for the account and any other person who entered or
accepted the order on behalf of the customer. If a person other than
the associated person responsible for the account entered the order
into an electronic system that generates the required memorandum and
the system is not capable of receiving an entry of the identity of any
person other than the responsible associated person, the member, broker
or dealer shall create a separate record which identifies each other
person upon request. An order entered pursuant to the exercise of
discretionary power by the member, broker or dealer, or associated
person or other employee thereof, shall be so designated. The term
instruction shall include instructions between partners and employees
of a member, broker or dealer. The term time of entry shall mean the
time when the member, broker or dealer transmits the order or
instruction for execution.
(7) A memorandum of each purchase and sale for the account of the
member, broker, or dealer showing the price and, to the extent
feasible, the time of execution; and, in addition, where the purchase
or sale is with a customer other than a broker or dealer, a memorandum
of each order received showing the terms and conditions of the order or
instructions and of any modification or cancellation thereof; the
account for which entered; the time the order was received; the time of
entry; the price at which executed; the time of execution or
cancellation, to the extent feasible; and, except as otherwise provided
in this paragraph, the identity of each associated person responsible
for the account and any other person
[[Page 54415]]
who entered or accepted the order on behalf of the customer. If a
person other than the associated person responsible for the account
entered the order into an electronic system that generates the required
memorandum and the system is not capable of receiving an entry of the
identity of any person other than the responsible associated person,
the member, broker or dealer shall create a separate record which
identifies each other person upon request. Orders entered pursuant to
the exercise of discretionary power by the member, broker or dealer, or
associated person or other employee thereof, shall be so designated.
The term instruction shall include instructions between partners and
employees of a member, broker or dealer. The term time of entry shall
mean the time when the member, broker or dealer transmits the order or
instruction for execution.
* * * * *
(12) * * *
(ii) A record of all agreements pertaining to the relationship
between each associated person and the member, broker or dealer.
(iii) A record containing a summary of each associated person's
compensation arrangement or plan with the member, broker or dealer,
including commission schedules.
(iv) A record identifying any internal identification number
assigned to each associated person by a member, broker or dealer and
the Central Registration Depository number, if any, assigned to each
associated person.
(v) A record listing each associated person on behalf of the
member, broker or dealer including the office of the member, broker or
dealer out of which the associated person works and the local office or
state record depository the records pertaining to that associated
person are preserved pursuant to Sec. 240.17a-4.
* * * * *
(16) For each account that has a natural person as the beneficial
owner (including a joint account with one or more natural persons as
the beneficial owners):
(i)(A) An account record containing the customer's name, Social
Security number (or other tax identification number), address and
telephone number, date of birth, marital status, number of dependents,
employment status (including occupation and whether the customer is an
associated person of a member, broker or dealer), annual income and net
worth (excluding value of primary residence), and investment objectives
or risk tolerance. In the case of a joint account, the information
shall be included for each individual on the joint account. The account
record shall indicate that it has been approved by the associated
person responsible for the account and by a principal of the member,
broker or dealer. If an account is a discretionary account, the record
must contain the dated signature of each customer granting the
discretionary authority and the dated signature of each person to whom
discretionary authority was granted.
(B)(1) Every member, broker or dealer shall furnish to each
customer within 30 days of opening the account and thereafter at least
once every 36 months (at intervals no greater than 36 months) a copy of
the customer's account record or an alternate document with all
information required by paragraph (a)(16)(i)(A) of this section. For an
account existing on [the effective date of the final rule], the initial
36 month period shall begin on [the effective date of the final rule].
For an account opened after [the effective date of the final rule] the
initial 36 month period shall begin on the day the initial account
record is sent to the customer
(2) For each account record of a customer updated to reflect a
change in the name, address, or investment objectives of the customer,
a member, broker or dealer shall furnish to that customer, no later
than 30 calendar days after the date it received notice of the change
of name, address, or investment objectives, a copy of that customer's
account record or an alternate document containing all required
information set forth on the account record. If the account is updated
to reflect a change of address, the member, broker or dealer shall
furnish the account record to the new address and a notice of the
change of address to the old address.
(3) The account record or alternate document furnished to the
customer shall include or be accompanied by a prominent statement
advising the customer that, if any information on the account record or
alternate document is incorrect, the customer should mark any
corrections and return the account record or alternate document to the
member, broker or dealer. Within 30 calendar days of receipt from a
customer any corrections or changes to the contents of an account
record or alternate document, a member, broker or dealer shall furnish
a copy of the revised account record or alternate document to the
customer and to the associated person who is responsible for that
customer's account.
(C) The neglect, refusal, or inability of a customer to provide or
update any required information for the customer's account record shall
excuse the member, broker or dealer from obtaining the required
information. The member, broker or dealer shall make a record of its
failure to obtain the required information when opening the account.
The record shall contain an explanation of the neglect, refusal, or
inability of the customer to provide the required information and the
name of the person that recorded the neglect, refusal, or inability on
behalf of the member, broker or dealer.
(ii) A record, which need not be separate from the account record,
for each account opened or updated after [the effective date of the
final rule] indicating compliance with any applicable regulations of a
securities regulatory authority that require certain information about
a customer be obtained when opening or updating a customer account.
This record shall include the date the member, broker or dealer
fulfilled its obligations regarding the opening or updating of the
customer account under any applicable regulations of a securities
regulatory authority.
(iii) A record indicating that the customer was furnished with a
copy of any written agreement pertaining to the customer's account. If
a member, broker or dealer furnishes to a customer a copy of any
written agreement that does not include the customer's signature, upon
request, the customer shall be furnished with a signed copy of the
written agreement pertaining to the customer's account.
(17)(i) A record as to each associated person of each written
customer complaint received by the member, broker or dealer concerning
that associated person. The record shall include, at least, the
complainant's name, address, and account number; the date the complaint
was received; the name of any associated person identified in the
complaint; a description of the nature of the complaint; and the
disposition of the complaint. Instead of the record, a member, broker
or dealer may maintain a copy of the original complaint along with a
record of the disposition of the complaint.
(ii) A record indicating that each customer of the member, broker
or dealer has been provided with a notice containing the address and
telephone number of the department of the member, broker or dealer to
which any complaints may be directed.
(18) A record as to each associated person listing all purchases
and sales of securities for which the associated person was
compensated, the amount of compensation (whether monetary or
[[Page 54416]]
nonmonetary), and the specific security involved. To the extent that
compensation is based on factors other than remuneration per trade,
such as a total production credit or bonus system, the member, broker
or dealer must be able to demonstrate and to document upon request the
method by which the compensation is determined. In lieu of making these
records, a member, broker or dealer may maintain, through electronic
means, the data necessary to promptly create the records upon request.
(19) A record indicating compliance with any applicable regulations
of a securities regulatory authority which require that materials used
by a member, broker or dealer or any associated person to offer or sell
any security have been approved by a principal. These materials may
include advertisements, marketing materials, sales scripts, and other
paper or electronic material, such as audio or video tapes. This
provision does not apply to those materials used only for internal
purposes.
(20) A record as to each associated person listing chronologically
all customer purchase or sale transactions for which the associated
person entered the orders or was primarily responsible for the
customer's account.
(21) A record listing all persons who, without delay, can explain
the information contained in the records (or type of records) required
pursuant to this section and those records required to be retained
pursuant to Sec. 240.17a-4.
(22) A record listing each principal of a member, broker or dealer
responsible for establishing policies and procedures that are
reasonably designed to ensure compliance with any applicable
regulations of a securities regulatory authority that require
acceptance or approval of a record by a principal.
(23) A record listing each office of a member, broker or dealer
indicating whether the office is a local office or has been designated
as a state record depository, and listing each associated person
working out of or storing records at that office.
* * * * *
(f) Every member, broker or dealer shall make and keep current,
separately for each office, the books and records described in
paragraphs (a)(1), (a)(6), (a)(7), (a)(12), (a)(16), (a)(17), (a)(18),
(a)(19), (a)(20), (a)(21), (a)(22) and (a)(23) of this section
reflecting the activities of that office. This requirement may be
satisfied by demonstrating that the data is maintained in a system
which is capable of promptly generating the records for each office
upon request.
(g) When used in this section:
(1) The term local office means any location where two or more
associated persons regularly conduct the business of handling funds or
securities or effecting any transactions in, or inducing or attempting
to induce the purchase or sale of any security, or otherwise soliciting
transactions or accounts for a member, broker or dealer.
(2) The term principal means any individual registered with the
National Association of Securities Dealers Regulation, Inc. as a
principal or branch manager of a member, broker or dealer.
(3) The term securities regulatory authority means the Commission,
any state securities regulatory agency authorized by law to examine
members, brokers or dealers subject to its jurisdiction, or any self-
regulatory organization.
3. Section 240.17a-4 is amended by revising paragraph (a), the
introductory text of paragraph (b), paragraphs (b)(1), (b)(4), and
(b)(7), the introductory text of paragraph (b)(8), and paragraphs (d),
and (j), and adding paragraphs (b)(10), (b)(11), (e)(5), (e)(6), (k)
and (l) to read as follows:
Sec. 240.17a-4 Records to be preserved by certain exchange members,
brokers and dealers.
(a) Every member, broker and dealer subject to Sec. 240.17a-3 shall
preserve for a period of not less than six years (the first two years
in an easily accessible place, subject to the provisions set forth in
paragraph (k) of this section) all records required to be made pursuant
to Sec. 240.17a-3(a) (1), (2), (3), (5), (16), (17), (21), (22) and
(23).
(b) Every member, broker and dealer subject to Sec. 240.17a-3 shall
preserve for a period of not less than three years (the first two years
in an easily accessible place, subject to the provisions set forth in
paragraph (k) of this section):
(1) All records required to be made pursuant to Sec. 240.17a-3(a)
(4), (6), (7), (8), (9), (10), (18), (19) and (20).
* * * * *
(4) Originals of all communications received and copies of all
communications sent by the member, broker or dealer (including inter-
office memoranda and communications) relating to its business as such.
The member, broker or dealer shall also retain any written approvals of
communications sent and any written procedures it uses for reviewing
the communications received or sent by the member, broker or dealer
(including inter-office memoranda and communications) relating to its
business as such.
* * * * *
(7) All written agreements (or copies thereof) entered into by the
member, broker or dealer relating to its business as such, including
agreements with respect to any account.
(8) Records which contain the following information in support of
amounts included in the report prepared as of the audit date on Form X-
17A-5 (Sec. 249.617 of this chapter) Part II or Part IIA and in annual
audited financial statements required by Sec. 240.17a-5(d):
* * * * *
(10) All materials used by the member, broker or dealer or any
associated person, to offer or sell any security, even if intended only
for internal use. These materials include advertisements, marketing
materials, sales scripts, and other paper or electronic materials, such
as audio and video recordings. The member, broker or dealer shall also
retain any written procedures for reviewing these materials.
(11) Copies of reports produced to review unusual activity in
customer accounts. These reports include, but are not limited to,
reports that identify exceptional numerical occurrences, such as
frequent trading in customer accounts, unusually high commissions, or
an unusually high number of trade corrections or cancelled
transactions. In lieu of retaining copies of the reports, a member,
broker or dealer may maintain, by electronic means, the data necessary
to promptly create the reports upon request.
* * * * *
(d) Every member, broker and dealer subject to Sec. 240.17a-3 shall
preserve during the life of the enterprise and of any successor
enterprise all Forms BD (Sec. 249.501 of this chapter), all Forms BDW
(Sec. 249.501a of this chapter), all amendments to the Forms, all
licenses or other documentation showing the member's, broker's or
dealer's registration with state securities jurisdictions and self-
regulatory organizations, and all partnership articles or, in the case
of a corporation, all articles of incorporation or charter, minute
books and stock certificate books.
(e) * * *
(5) All reports requested or required by a securities regulatory
authority and any securities regulatory examination reports until at
least three years after the date of the report.
(6) All compliance, supervisory, and procedures manuals describing
the policies and practices of the member, broker or dealer with respect
to operations, compliance with all
[[Page 54417]]
applicable securities laws and regulations, and supervision of the
activities of each natural person associated with the member, broker or
dealer until at least three years after the termination of the use of
each manual.
* * * * *
(j) Every member, broker or dealer subject to this section shall
furnish promptly to a representative of the Commission legible, true,
and complete copies of those records of the member, broker or dealer,
that are required to be preserved under this section, or any other
records of the member, broker or dealer subject to examination under
Section 17(b) of the Act (15 U.S.C. 78q(b)) that are requested by the
representative of the Commission.
(k) Records required to be preserved by the provisions of this
section must be maintained at the headquarters office or other
centralized location of a member, broker or dealer. In addition,
records required to be maintained by Sec. 240.17a-3(a)(1), (a)(6),
(a)(7), (a)(12), (a)(16), (a)(17), (a)(18), (a)(19), (a)(20), (a)(21),
and (a)(22) and paragraphs (b)(4) and (e)(6) of this section which:
(1) Relate to a local office shall also be maintained at the local
office as follows:
(i) The most recent one year period of the records pertaining to a
local office shall be maintained at the local office of a member,
broker or dealer; or
(ii) In lieu of maintaining records at the local office, a member,
broker or dealer may comply with the local office record maintenance
requirements of this section by having the capability of producing
printed copies of the records at the local office during the same
business day as the request for the records is made or, if unusual
circumstances prevent the production of printed copies of the records
within the same business day, with the permission of the securities
regulator making the request, the records shall be made available
within a reasonable time. This capability shall not be deemed to
supersede paragraph (f) of this section.
(2) Relate to an office of a member, broker or dealer that does not
meet the definition of local office under Sec. 240.17a-3(g)(1), or
relate to an associated person who works out of multiple offices of a
member, broker or dealer, must be either maintained at the office, or
aggregated with the records of one or more other such offices or
associated persons at a state record depository designated by the
member, broker or dealer if the following requirements are met:
(i) The state record depository, which may be another office of the
member, broker or dealer, is located within the same state as the
office that does not meet the definition of local office, and with
respect to maintaining records for an associated person who works out
of multiple offices, the state record depository is located in each
state in which the associated person conducts its business; and
(ii) The records stored in the state record depository can be
easily identified and accessed for each office that does not meet the
definition of local office or for each associated person to the same
extent as if each such office or associated person kept separate
records in compliance with the local office recordkeeping requirements
of this section.
(l) When used in this section:
(1) The term local office shall have the meaning set forth in
Sec. 240.17a-3(g)(1).
(2) The term principal shall have the meaning set forth in
Sec. 240.17a-3(g)(2).
(3) The term securities regulatory authority shall have the meaning
set forth in Sec. 240.17a-3(g)(3).
Sec. 240.17a-4 [Amended]
4. In Sec. 240.17a-4, paragraph (f)(3)(ii) is amended by removing
the phrase ``the Commission or its representatives'' and in its place
adding ``the staffs of the Commission, any self-regulatory organization
of which it is a member, or any state securities regulator having
jurisdiction over the member, broker or dealer''.
5. In Sec. 240.17a-4, paragraph (f)(3)(vii) is amended by:
a. Removing the phrase ``the U.S. Securities and Exchange
Commission (``Commission''), its designees or representatives,'' and in
its place adding ``the U.S. Securities and Exchange Commission
(``Commission''), its designees or representatives, any self-regulatory
organization of which it is a member, or any state securities regulator
having jurisdiction over the member, broker or dealer,'';
b. Removing the phrase ``the Commission's or designee's staff'' and
in its place adding ``the staffs of the Commission, any self-regulatory
organization of which it is a member, or any state securities regulator
having jurisdiction over the member, broker or dealer'';
c. Removing each place it appears the phrase ``the Commission's
staff or its designee'' and in its place adding ``the staffs of the
Commission, any self-regulatory organization of which it is a member,
or any state securities regulator having jurisdiction over the member,
broker or dealer''.
Dated: October 2, 1998.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-27120 Filed 10-8-98; 8:45 am]
BILLING CODE 8010-01-P