[Federal Register Volume 66, Number 213 (Friday, November 2, 2001)]
[Rules and Regulations]
[Pages 55818-55841]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-27439]



[[Page 55817]]

-----------------------------------------------------------------------

Part III





Securities and Exchange Commission





-----------------------------------------------------------------------



17 CFR Parts 240 and 242



Books and Records Requirements for Brokers and Dealers Under the 
Securities Exchange Act of 1934; Final Rule

  Federal Register / Vol. 66, No. 213 / Friday, November 2, 2001 / 
Rules and Regulations  

[[Page 55818]]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 242

[Release No. 34-44992; 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: Final rule; request for comments on Paperwork Reduction Act 
burden estimate.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission today is adopting 
amendments to its broker-dealer books and records rules. The amendments 
clarify and expand recordkeeping requirements with respect to purchase 
and sale documents, customer records, associated person records, 
customer complaints, and certain other matters. In addition, the 
amendments expand the types of records that broker-dealers must 
maintain and require broker-dealers to maintain or promptly produce 
certain records at each office to which those records relate. These 
amendments are specifically designed to assist securities regulators 
when conducting sales practice examinations of broker-dealers, 
particularly examinations of local offices.

EFFECTIVE DATE: May 2, 2003.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 942-0131; Thomas K. McGowan, Assistant Director, at 
(202) 942-4886; or Bonnie L. Gauch, Attorney, at (202) 942-0765; Office 
of Risk Management and Control, Division of Market Regulation, United 
States Securities and Exchange Commission, 450 Fifth Street, NW, 
Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION:

I. Introduction

    The Securities and Exchange Commission's (the ``Commission'') books 
and records rules, Rule 17a-3\1\ and Rule 17a-4 \2\ under the 
Securities Exchange Act of 1934 (``Exchange Act'')(hereinafter the 
``Books and Records Rules''), specify minimum requirements with respect 
to the records that broker-dealers must make, and how long those 
records and other documents relating to a broker-dealer's business must 
be kept. The Commission has required that broker-dealers create and 
maintain certain records so that, among other things, the Commission, 
self-regulatory organizations (``SROs''), and State Securities 
Regulators \3\ (collectively ``securities regulatory authorities'') may 
conduct effective examinations of broker-dealers.
---------------------------------------------------------------------------

    \1\ 17 CFR 240.17a-3.
    \2\ 17 CFR 240.17a-4.
    \3\ For purposes of this release, ``State Securities 
Regulators'' include, as described in Section 15(h) of the Exchange 
Act, ``the securities commissions (or any agency or office 
performing like functions) of the States.'' 15 U.S.C. 78o(h).
---------------------------------------------------------------------------

    The Commission originally proposed amending the Books and Records 
Rules in 1996 in response to concerns raised by members of the North 
American Securities Administrator's Association (``NASAA'') regarding 
the adequacy of those Rules.\4\ On October 11, 1996, the National 
Securities Market Improvement Act of 1996 (``NSMIA'') was enacted.\5\ 
NSMIA prohibits States from establishing books and records rules that 
differ from, or are in addition to, the Commission's rules. Prior to 
NSMIA many States had laws or rules that required broker-dealers to 
make and keep certain books and records that allowed the State 
Securities Regulators to conduct examinations and investigations to 
review for, among other things, sales practice violations.\6\ NSMIA 
also provides that the Commission must consult periodically with the 
States concerning the adequacy of the Commission's Books and Records 
Rules,\7\ particularly relating to the need by State Securities 
Regulators to have records readily accessible for their 
examinations.\8\
---------------------------------------------------------------------------

    \4\ See Exchange Act Release No. 37850 (October 22, 1996), 61 FR 
55593 (Oct. 28, 1996) (``Proposing Release'' and/or ``Proposal'') 
(File No. S7-27-96).
    \5\ Pub. L. No. 104-290, 110 Stat. 3416 (1996).
    \6\ E.g., violations of State suitability and fraud laws, or 
federal regulations.
    \7\ 15 U.S.C. 78o(h).
    \8\ 142 Cong.Rec.S. 12093, S12094 (October 1, 1996) (statement 
of Sen. Dodd) (``It is the intent of the conferees that the SEC work 
closely with the States to determine what records should be 
maintained at branch offices and to establish a mechanism so that 
States could require such records be kept in the branch office, 
rather than at a back office halfway across the Nation.'').
---------------------------------------------------------------------------

    The Commission, recognizing the vital role that State regulators 
play in providing for customer protection, issued the Proposing 
Release, in part, to enhance the ability of the State Securities 
Regulators to conduct effective and efficient sales practice 
examinations of activities within their respective States, including 
those involving smaller broker-dealer offices. By adopting these rules, 
the Commission enables the State regulators to adopt and enforce 
similar rules on a State level, to support their examination 
responsibilities, and investigatory and enforcement requirements. An 
important aspect of the amendments is that broker-dealers are required 
to produce records at offices within a State. Moreover, many of these 
amendments require broker-dealers to make or keep records currently 
kept by broker-dealers as a matter of business practice or to comply 
with SRO rules. However, unless these requirements are adopted as 
Commission rules, the State regulators are unable to apply or enforce 
them at the State level.

II. Proposing and Reproposing Releases

    In response to the comments received on the Proposing Release, the 
Commission substantially modified the amendments, and reproposed them 
to allow for public comment on the modifications.\9\ In response to the 
reproposal, the Commission received approximately 115 comment letters 
from various groups, including broker-dealers, law firms representing 
broker-dealers, industry associations, and State Securities Regulators. 
Generally, State Securities Regulators supported the rules as 
reproposed, but suggested some minor changes. While broker-dealers 
generally supported the Commission's efforts to adopt uniform books and 
records rules, they opposed various sections of the reproposed rules. 
In particular, firms were opposed to the requirements to periodically 
update the customer account record and to maintain records at local 
offices. As discussed in the respective sections throughout this 
release, the Commission has substantially modified the content of the 
re-proposed amendments and incorporated many of the suggested changes 
into the final rules.
---------------------------------------------------------------------------

    \9\ Exchange Act Release No. 40518 (Oct. 2, 1998), 63 FR 54404 
(Oct. 9, 1998) (the ``Reproposing Release'' and/or ``Reproposal''). 
The staff of the Division of Market Regulation has prepared a 
summary of the comment letters received on the reproposed rules and 
rule amendments (hereinafter referred to as ``Comment Summary''). 
Copies of the comment letters and the Comment Summary have been 
placed in Public Reference File No. S7-26-98 and are available for 
inspection in the Commission's Public Reference Room.
---------------------------------------------------------------------------

    To a significant degree, the amendments to Rules 17a-3 and 17a-4 
adopted by the Commission track existing SRO requirements and certain 
State regulations that were in place prior to NSMIA. In addition, they 
largely represent a codification of prudent recordkeeping practices of 
many broker-dealers. Accordingly, many portions of the Books and 
Records Rule amendments should not present additional burdens for most 
broker-dealers.

[[Page 55819]]

III. Amendments to Rule 17a-3

    In brief, the amendments to present Rule 17a-3 include revisions to 
the information that must be recorded on order tickets, and new 
requirements to: create certain records relating to associated persons; 
collect certain account record information and verify that information 
with customers periodically; create a record of customer complaints; 
create a record indicating compliance with applicable advertising 
rules; and create records identifying persons responsible for 
establishing procedures and persons able to explain the broker-dealer's 
records to a regulator.

A. Memoranda of Brokerage Orders and Dealer Transactions

    Rule 17a-3 has been amended to require that a brokerage order 
ticket contain the identity of the associated person, if any, 
responsible for the account and any other person who entered or 
accepted the order on behalf of the customer, and whether it was 
entered subject to discretionary authority. In addition, a brokerage 
order ticket must include the time at which the broker-dealer received 
a customer order, even if the order is subsequently transmitted for 
execution.\10\ A dealer ticket must include information regarding any 
modifications to the order.\11\ This will allow securities regulators 
to better focus their examinations and investigations because they will 
be able to identify certain types of violative activities and the 
individuals responsible for those activities more easily.
---------------------------------------------------------------------------

    \10\ 17 CFR 240.17a-3(a)(6). Most broker-dealers are currently 
required to record the time the order was received from a customer 
under the National Association of Securities Dealers' (``NASD'') 
Order Audit Trail System (``OATS'') rules (NASD rules 6950 through 
6957 and 3110) (hereinafter ``OATS rules'') (See specifically NASD 
rules 6954(b)(16) and 3110(h)), and New York Stock Exchange 
(``NYSE'') rules 123 and 410A.
    \11\ 7 CFR 240.17a-3(a)(7).
---------------------------------------------------------------------------

    The Commission clarified that the identity of the associated person 
responsible for the account must be included only if the broker-dealer 
assigns to an associated person responsibility for certain accounts. 
This modification was made in response to broker-dealer comment letters 
that noted some firms do not assign a particular associated person to 
each account, and some firms allow customers to enter orders directly 
into a broker-dealer's systems, such as through an on-line trading 
account. Further, this modification addresses the concerns of some 
commenters that without a qualifying phrase, such as ``if any,'' the 
rule may be interpreted erroneously as placing on firms an affirmative 
obligation to assign an associated person to each account.
    If a firm has assigned identification numbers or codes to the 
persons entering customer orders to comply with the requirement to 
record the identity of the person entering customer orders, a broker-
dealer may record the identification number or code on the order ticket 
instead of the associated person's name. Further, if the person 
entering a customer order has been assigned to a computer terminal but 
does not have a specific identification number or code, it is 
acceptable for the broker-dealer to identify the number or code of a 
computer terminal at which an order was entered. In either case, upon 
request by a representative of a securities regulatory authority, the 
firm must provide the actual identity of the person who entered the 
order. Either of these alternatives may be satisfied by using a 
companion record to the order tickets.\12\
---------------------------------------------------------------------------

    \12\ E.g., a firm may satisfy this requirement by using the 
record listing any internal identification number or code assigned 
to associated persons which is required under new Rule 17a-
3(a)(12)(ii) (17 CFR 240.17a-3(a)(12)(ii)). Additionally, the 
Commission believes this requirement is consistent with the NASD's 
OATS rules.
---------------------------------------------------------------------------

    With these amendments, paragraphs (a)(6) and (a)(7) require that 
broker-dealers record the identity of ``any [person other than the 
associated person responsible for the account] who entered or accepted 
the order on behalf of the customer.'' In response to comments by the 
online brokerage community, the Commission included, after this 
requirement, the phrase, ``if a customer entered the order on an 
electronic system, a notation of such entry.'' Because most firms that 
accept orders through an electronic system already identify, for 
supervisory purposes, which orders were entered directly by a customer, 
this requirement will not create much additional burden on the firms. 
Further, it will assist them in identifying for securities regulatory 
authorities why certain tickets do not identify the associated person 
who received the order from the customer.
    One commenter argued that firms that primarily accept 
``unsolicited'' orders and do not pay transaction-based commissions 
should not be required to include on the order ticket information 
regarding associated persons because no sales practice concerns would 
be implicated in these types of transactions. However, the Commission 
believes that recording the identity of the associated person on a 
broker-dealer's order tickets is essential for adequate surveillance 
of, and accountability for, transactions.
    One commenter wrote that for some transactions the time of entry 
frequently is simultaneous or nearly simultaneous with the time the 
order is received, and suggested that under these conditions, the firm 
should not have to make a separate entry for each time. In those 
situations, it must be clear from the order ticket that the time of 
receipt was the same as the time of entry. However, the time recorded 
must be accurate and this should not be construed as an exception to 
allow firms to use an approximate time for one or both entries.\13\
---------------------------------------------------------------------------

    \13\ 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. The Commission has stated that the ``phrase 
``to the extent feasible'' was intended to be applicable only in 
exceptional circumstances where it might be actually impossible to 
determine the exact time of execution.'' Exchange Act Release No. 
13508 (May 5, 1977) 42 FR 25318. However, in that case the broker-
dealer must note the approximate time of execution.
---------------------------------------------------------------------------

    Finally, the Commission recognizes that for some types of 
transactions, such as purchases of mutual funds or variable annuities, 
the customer may simply fill out an application or a subscription 
agreement that the broker-dealer then forwards directly to the 
issuer.\14\ These documents would include the information that is 
important for and specific to the particular type of transaction. 
Hence, the Commission has added paragraph (a)(6)(ii) under Rule 17a-3 
to allow firms to keep a copy of the application or subscription 
document instead of making a separate record as to transactions 
described in the exemption. This paragraph would also exempt 
transactions such as automatic dividend reinvestments. The Commission 
views this additional paragraph as a codification of current industry 
practice, and it is limited to these types of transactions.
---------------------------------------------------------------------------

    \14\ This is referred to elsewhere in the rules as a 
``subscription-way basis'' transaction. See 17 CFR.15c3-1(a)(2)(v).
---------------------------------------------------------------------------

B. Associated Person Records

1. New Records Concerning Associated Persons
    Rule 17a-3(a)(12) requires a firm to make records relating to 
associated persons of the firm, including information regarding the 
associated person's employment and disciplinary history. The amendments 
require a record listing all of a firm's associated

[[Page 55820]]

persons showing every office where each associated person regularly 
conducts business, and listing all internal identification numbers and 
the CRD number assigned to each associated person.\15\ This will allow 
securities regulators to identify where associated persons work, and to 
read various records which may identify the associated persons solely 
through the use of identification numbers. Also, three technical 
changes were made from the rule as reproposed.\16\
---------------------------------------------------------------------------

    \15\ 17 CFR 240.17a-3(a)(12)(ii).
    \16\ First, reproposed paragraphs (a)(12)(ii) and (a)(12)(iii) 
have been moved to paragraph (a)(19) of Rule 17a-3 to keep all 
requirements relating to compensation records in the same section 
(most agreements between associated persons and broker-dealers 
relate to compensation in some manner). Second, reproposed 
paragraphs (a)(12)(iv) and (a)(12)(v) have been combined into new 
paragraph (a)(12)(ii). And finally, the Commission has deleted the 
references to local offices and state record depositories to make 
this paragraph consistent with the changes to the definition of 
``office'' in paragraph (g)(1) of Rule 17a-3.
---------------------------------------------------------------------------

2. The Definition of Associated Person
    The Commission had proposed to eliminate from Rule 17a-3 a 
definition of ``associated person'' and instead use the definition of 
``associated person'' as defined in sections 3(a)(18) and 3(a)(21) of 
the Exchange Act. However, the statutory definition of ``associated 
person of a broker or dealer'' in section 3(a)(18) specifically 
excludes those persons whose functions are clerical or ministerial from 
the definition solely for purposes of section 15(b) of the Exchange 
Act. Current Rule 17a-3 excludes those persons from the recordkeeping 
requirements. The Commission has determined that those persons should 
continue to be exempt from the recordkeeping requirements of Rules 17a-
3 and 17a-4. Therefore, the Commission believes it is appropriate to 
retain a definition of the term ``associated person'' in the rule. This 
definition has been moved to paragraph (g), however, and has been 
modified for the sake of uniformity to incorporate the definitions of 
``associated person of a member'' and ``associated person of a broker 
or dealer'' as set forth in sections 3(a)(21) and 3(a)(18) of the 
Exchange Act.\17\ In addition, for purposes of Rules 17a-3 and 17a-4, 
the Commission has excluded from the definition persons whose functions 
are solely clerical or ministerial. In order to avoid redundancy and 
achieve greater consistency in interpretation, this phrase shall be 
interpreted in the same manner as the phrase ``solely clerical and 
ministerial'' is interpreted under section 3(a)(18) of the Exchange 
Act.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78c(a)(21) and 15 U.S.C. 78c(a)(18).
---------------------------------------------------------------------------

    The Exchange Act provisions define an associated person to include 
any partner, officer, director, or branch manager of a broker-dealer 
(any person occupying a similar status or performing similar 
functions), any person directly or indirectly controlling, controlled 
by, or under common control with a broker-dealer, or any employee of a 
broker-dealer. This includes order-takers. 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.\18\
---------------------------------------------------------------------------

    \18\ The Commission has consistently taken the position that 
independent contractors (who are not themselves registered as 
broker-dealers) involved in the sale of securities on behalf of a 
broker-dealer are ``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 Douglas 
Scarff, Director, Division of Market Regulation, to Gordon S. 
Macklin, NASD; Charles J. Henry, Chicago Board Options Exchange; 
Robert J. Birnbaum, American Stock Exchange; and John J. Phelan, 
NYSE, [1982-1983 Transfer Binder] Fed. Sec. L. Rep. (CCH) P77,303 at 
P77,116 (Jun. 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.
---------------------------------------------------------------------------

C. Customer Account Record

    The Commission is adopting new Rule 17a-3(a)(17) \19\ under the 
Exchange Act, which requires broker-dealers to create a record 
containing certain minimum information as to each customer. The primary 
purpose of Rule 17a-3(a)(17) is to provide regulators, particularly 
State Securities Regulators, with access to books and records which 
enable them to review for compliance with suitability rules.\20\ Rule 
17a-3(a)(17) also requires broker-dealers to furnish that information 
to each customer on a periodic basis. The rule should not be construed 
to affect or supersede any Federal, State, or SRO requirement, 
including those relating to ``know your customer,'' suitability, or 
supervisory obligations.
---------------------------------------------------------------------------

    \19\ This provision was reproposed as Rule 17a-3(a)(16).
    \20\ Generally, suitability rules require that broker-dealers 
and their associated persons refrain from recommending transactions 
or investment strategies to a customer that would be ``unsuitable'' 
for that customer based upon the customer's situation. Factors that 
may be considered in assessing a customer's situation include the 
customer's age, financial situation, and investment experience or 
knowledge of the industry.
---------------------------------------------------------------------------

1. Account Record Information
    The information required under new Rule 17a-3(a)(17)(i)(A) for each 
account with a natural person as a customer includes the customer's 
name, tax identification number, address, telephone number, date of 
birth, employment status (including occupation and whether the customer 
is an associated person of a member, broker or dealer), annual income, 
net worth (excluding value of primary residence), and investment 
objectives. Most broker-dealers already collect this information to 
assist them in assessing customers' suitability or to comply with other 
rules. For accounts with more than one owner, the record should include 
personal information for each owner of the account; however, the record 
should reflect the investment objectives for the account and not the 
individual investment objectives for each ``joint'' owner named on the 
account. Further, financial information for the owners can be combined. 
For discretionary accounts, firms also must include as part of the 
account record the dated signature of each customer granting the 
discretionary authority and the dated signature of each natural person 
\21\ to whom discretionary authority was granted. In response to 
comments received, the Commission did not adopt the reproposed 
requirement that the account record include information regarding a 
customer's marital status and number of dependents.\22\
---------------------------------------------------------------------------

    \21\ See NYSE Rule 408 and NASD Rule 2510(b).
    \22\ See, e.g., Comment Letters from Raymond James, p. 4; 
Investment Management and Research, p. 3, and Mayer, Brown & Platt, 
pp. 6-7.
---------------------------------------------------------------------------

    Under the final rule, the account record must indicate whether it 
has been signed by the associated person responsible for the account, 
and approved or accepted by a principal of the firm.\23\ This will 
identify for regulators the persons responsible for accepting a 
particular account on behalf of the firm. Similar to the comments made 
regarding order tickets, some commenters stated that they do not always 
assign an associated person to each account. Therefore, the Commission 
has added the phrase ``if any'' to the requirement that the account 
record indicate whether it has been approved by an associated person. 
The account record still must indicate

[[Page 55821]]

whether it has been approved by a principal.\24\
---------------------------------------------------------------------------

    \23\ 17 CFR 240.17a-3(a)(17)(i)(A). This requirement is 
consistent with SRO rules regarding the signatures of associated 
persons and principals when opening customer accounts. See NYSE Rule 
405(3) and NASD Rule 3110(c)(1)(C).
    \24\ The Commission believes that this requirement is consistent 
with SRO requirements regarding customer accounts such as those 
discussed above in footnote 23.
---------------------------------------------------------------------------

    In the Reproposal, the Commission specifically sought comment on 
whether, for joint accounts, the firm should obtain the account record 
information for each individual. Most commenters that addressed this 
issue did not object to maintaining personal information for each owner 
of joint accounts. However, some commenters pointed out that it would 
be unnecessary and redundant to obtain individual information for 
certain types of joint accounts, such as a joint account of two spouses 
with similar information regarding income and net worth. These 
commenters also contended that the investment objectives should reflect 
the objectives for the account and not the objectives of the individual 
owners. In those cases, it is sufficient under paragraph (a)(17) of 
Rule 17a-3 \25\ that the account record reflect that portions of the 
account record information are the same for each owner of the account. 
It is acceptable for firms to combine joint owners' financial 
information as opposed to obtaining and maintaining that information 
separately for each of the joint owners. Lastly, the investment 
objectives recorded should be those for the account, and not those of 
the individual owners.
---------------------------------------------------------------------------

    \25\ 17 CFR 240.17a-3(a)(17).
---------------------------------------------------------------------------

    Some commenters requested clarification as to how this information 
must be maintained and whether all the information and signatures must 
be included on the same form.\26\ Although a broker-dealer must create 
a single record for each account, that record may consist of more than 
one document, such as two or more account applications.
---------------------------------------------------------------------------

    \26\ See Comment Letters from Donaldson, Lufkin and Jenrette, p. 
9, and the International Association for Financial Planning, pp. 2-
3.
---------------------------------------------------------------------------

    A broker-dealer is not required to furnish a copy of a customer's 
account record to the customer within thirty days when obtaining new 
information to complete the initial account record, required under Rule 
17a-3(a)(17)(i)(A),\27\ for an account in existence on the effective 
date of the rule amendments. However, as stated in Rule 17a-
3(a)(17)(i)(B)(1),\28\ broker-dealers must create a record indicating 
that the broker-dealer furnished these customers with a copy of the 
account record information within three years of the effective date of 
the rule.
---------------------------------------------------------------------------

    \27\ 17 CFR 240.17a-3(a)(17)(i)(A).
    \28\ 17 CFR 240.17a-3(a)(17)(i)(B)(1).
---------------------------------------------------------------------------

2. Furnishing the Account Record Information
    Rule 17a-3(a)(17) requires that the firm periodically furnish 
account record information to the customer.\29\ The new requirement 
allows the customer to review the information regarding the account 
that the firm has on file and from which the associated person or the 
firm is making investment recommendations or suitability determinations 
for the account. The requirement to furnish this record to customers is 
designed to reduce the number of misunderstandings between customers 
and broker-dealers regarding the customer's situation or investment 
objectives. Firms may, of course, elect to provide this information to 
customers more frequently in order to coincide with other mailings.
---------------------------------------------------------------------------

    \29\ Certain SRO rules already require that customer account 
records be sent to customers who open options accounts. See NASD 
Rule 2860(b)(16)(C) and IM-2860-2, and NYSE Rule 721(c) and 
Supplemental Material at .30 regarding options accounts.
---------------------------------------------------------------------------

    Paragraph (a)(17) of the rule identifies four provisions that 
trigger the requirement that a broker-dealer furnish to a customer a 
copy of information contained in the account record.\30\ Those 
provisions include (i) the opening of a new account;\31\ (ii) the 
periodic updating of an account that must occur at least once every 36 
months;\32\ (iii) a change of customer name or address;\33\ and (iv) a 
change of other customer information.\34\
---------------------------------------------------------------------------

    \30\ 17 CFR 240.17a-3(a)(17)(i)(B)(1) through (B)(3).
    \31\ 17 CFR 240.17a-3(a)(17)(i)(B)(1).
    \32\ Id.
    \33\ 17 CFR 240.17a-3(a)(17)(i)(B)(2).
    \34\ 17 CFR 240.17a-3(a)(17)(i)(B)(3).
---------------------------------------------------------------------------

    Although paragraph (a)(17)(i) of Rule 17a-3 requires broker-dealers 
to periodically update customer records, the rule does not affect a 
broker-dealer's obligations under any SRO ``know your customer'' rules. 
It may be appropriate in certain circumstances for broker-dealers to 
obtain updated information from customers more often than once every 36 
months.
    Because different terms ascribed to categories of investment 
objectives may vary among firms, the firms must describe these terms 
when furnishing the account record to customers. When opening an 
account, the customer has the opportunity to question the meaning of 
the investment objective terms, but when the customer receives a copy 
of the account record at home, that customer may have forgotten or 
misunderstood the meaning of those terms. This requirement to describe 
investment objective terminology should help ensure that the customer 
and the firm have a mutual understanding of the meaning of each term.
    Paragraph (a)(17) of Rule 17a-3 also provides that a broker-dealer 
is not required to include the customer's tax identification number and 
date of birth with the information provided to the customer. Several 
commenters suggested that unauthorized access to such information could 
facilitate the perpetration of fraud against the customer.\35\
---------------------------------------------------------------------------

    \35\ See Comment Letters from Fidelity Investments, p. 5, 
Benefits Communication Corporation, p. 1, American Express Financial 
Advisors, Inc., p. 4, and Comerica Securities, p. 3.
---------------------------------------------------------------------------

    The Commission did not adopt the portion of the rule as reproposed 
that would have required firms to send a notification of change of 
address to both the old and new addresses. This change was in response 
to comments that prudent business practice requires that this 
notification be sent only to the old address to prevent misdirection of 
account information. Therefore, as adopted, firms are required to send 
a notification of a change of address only to the old address.
    Some commenters sought clarification as to whether the amendment 
required a separate mailing of the customer account record information. 
This rule does not require a separate mailing, and the Commission 
anticipates that firms will combine this mailing with other mailings. 
Further, the account record information may be printed on a customer's 
account statement. Finally, a firm may mail the customer a copy of the 
customer's complete account record reflecting any change of other 
account record information \36\ on or before the 30th day after the 
date the member, broker or dealer received notice of any change, or it 
may choose to send this notification with the next statement scheduled 
to be mailed to the customer.
---------------------------------------------------------------------------

    \36\ 17 CFR 240.17a-3(a)(17)(i)(B)(4).
---------------------------------------------------------------------------

3. Explanation of the Neglect, Refusal, or Inability of a Customer To 
Provide Required Information
    As adopted, Rule 17a-3(a)(17)(i)(C) does not require broker-dealers 
to include an explanation of the customer's neglect, refusal, or 
inability to provide the required information. However, a broker-dealer 
is required to make a good faith effort to collect this information. If 
the account record does not include the required information, the 
broker-dealer would bear the burden of explaining why this information 
is not available. Rule 17a-3(a)(17)(i)(C) is

[[Page 55822]]

specifically limited in application to paragraph (a)(17), and does not 
apply to any other Federal or SRO rules regarding collections of 
information (e.g., Rule 17a-3(a)(9)).
4. Exemption From Account Record Information Requirements
    A number of broker-dealer firms argued that the Commission should 
create an exemption from the account record information requirements of 
Rule 17a-3(a)(17)(i), contending that this record is intended to allow 
examiners to review for suitability, but broker-dealers are not subject 
to SRO suitability requirements for all of their accounts.\37\ 
Therefore, they argue, where they have no suitability obligation, they 
should not be required to obtain account record information. The 
Commission is adopting the account record requirements with an 
exemption for certain accounts,\38\ such that a broker-dealer is not 
required to create an account record for an account if the firm is not 
required (under any Federal or SRO rules) to make a suitability 
determination as to the account. However, the obligation to collect and 
record information of the type enumerated in Rule 17a-3(a)(17)(i)(A) 
may arise under SRO rules and interpretations. If, after the account is 
opened, the firm or its associated person engage in conduct that would 
subject the firm to any requirement to make a suitability 
determination, the firm must obtain the information before making such 
a recommendation. The firm would have to comply thereafter with the 
requirement to furnish customers with a copy of their account record 
for verification, under paragraph (a)(17)(i)(B)(1) of Rule 17a-3, but 
the account could re-qualify for the exemption.
---------------------------------------------------------------------------

    \37\ See, e.g., NASD Rules 2310 and 2860(b)(16)(B), NYSE Rule 
723, Chicago Board Options Exchange Rule 9.9, and Municipal 
Securities Rulemaking Board Rule G-19.
    \37\ 17 CFR 240.17a-3(a)(17)(i)(D).
---------------------------------------------------------------------------

    For accounts existing on the effective date of these amendments, a 
broker-dealer will not be required to create or update the account 
record if, within the 36-month period beginning on the effective date 
of this rule, the firm has not been required to make a suitability 
determination as to that account.
    For the purposes of paragraph (a)(17)(i)(D) of Rule 17a-3, the term 
``suitability determination'' should be interpreted broadly. A broker-
dealer may have an obligation to perform a suitability determination 
under the Exchange Act,\39\ Commission rules,\40\ SRO rules,\41\ or 
common law.\42\ Rule 17a-3(a)(17) does not change or limit a broker-
dealer's obligation to make a suitability determination.
---------------------------------------------------------------------------

    \39\ Sections 10(b) and 15(c) (15 U.S.C. 78j(b) and 15 U.S.C. 
78o(c)). See e.g., Hanley v. SEC, 415 F.2d 589, 596 (2d Cir. 1969); 
F.J. Kaufman and Co., 50 S.E.C. 164 (1989); O'Connor v. R.F.Lafferty 
& Co., 965 F.2d 893 (10th Cir. 1992).
    \40\ 17 CFR 240.10b-5 and 17 CFR 240.15c1-2.
    \41\ See supra note 37.
    \42\ If a recommendation is made, a suitability obligation 
arises irrespective of the medium used to deliver that 
recommendation. For example, a broker-dealer can make a 
recommendation in person, on a website, via telephone, mail, or 
email. A broker-dealer also can recommend a security online 
regardless of whether that recommendation is attributable to a 
specific registered representative. Whether a broker-dealer has made 
a recommendation is a question that can only be answered by 
considering all of the facts and circumstances. (See ``Suitability 
Hypotheticals,'' Report of Commissioner Laura S. Unger, Online 
Brokerage: Keeping Apace of Cyberspace, pp. 32-4. (Nov. 1999))
---------------------------------------------------------------------------

    It is important to note that even if a broker-dealer is not 
required to create an account record under Rule 17a-3(a)(17) for an 
account, the firm must still comply with federal laws and regulations 
and SRO rules requiring collections of information regarding customer 
accounts, including paragraph (a)(9) of Rule 17a-3,\43\ NYSE Rule 405, 
and MSRB Rule G-8(a)(xi).
---------------------------------------------------------------------------

    \43\ 17 CFR 240.17a-3(a)(9).
---------------------------------------------------------------------------

5. Applicability of Account Record Requirements and 36-Month Grace 
Period
    The requirement to create an account record applies to both new and 
existing accounts. For accounts opened on or after the effective date 
of these amendments (``new accounts''), the firm must obtain the 
account record information required under Rule 17a-3(a)(17)(i)(A) when 
the account is opened.
    As originally proposed, the grace period to obtain the customer 
account record information for accounts existing on the effective date 
of these amendments would have been one year. However, many commenters 
\44\ stated that with a large number of accounts it would be unduly 
burdensome to obtain the account record information within one year. 
Therefore, the Commission has provided broker-dealers with a 36-month 
grace period. Specifically, under paragraph (B)(1) of Rule 17a-
3(a)(17)(i), for accounts existing on the effective date of these 
amendments, a firm will have 36 months to obtain the information 
required on the account record under paragraph (a)(17)(i)(A) of Rule 
17a-3. The new 36-month furnishing cycle under paragraph (a)(17)(i)(B) 
of Rule 17a-3 will begin when the firm obtains the account record 
information within the initial 36-month grace period.
---------------------------------------------------------------------------

    \44\ See, e.g., Comment Letter of Salomon Smith Barney, pp. 3-4.
---------------------------------------------------------------------------

6. Written Customer Agreements
    New paragraph (a)(17)(iii) of Rule 17a-3 requires each broker-
dealer to create a record for each account indicating that each 
customer was furnished with a copy of any written agreement entered 
into on or after the effective date of this paragraph pertaining to 
that account. This will allow customers to review the terms of 
agreements to which they are subject, and to better understand their 
rights and responsibilities (and those of the broker-dealer) under 
these agreements. In addition, if any customer specifically requests a 
copy of an agreement relating to their account, this paragraph would 
require that the broker-dealer maintain a record that it was provided 
to the customer.

D. Complaints

    New paragraph (a)(18)(i) of Rule 17a-3 \45\ requires firms to make 
a record as to each associated person that includes every written 
customer complaint received by the firm concerning that associated 
person.\46\ This will allow securities regulators to quickly identify 
any trends, and focus examinations. This record must include complaints 
received electronically from customers. The rule requires that the 
record include the complainant's name, address, and account number; the 
date the complaint was received; the name of each associated person 
identified in the complaint; a description of the nature of the 
complaint; and the disposition of the complaint. However, because firms 
already are required to keep originals of incoming written 
complaints,\47\ rather than make a separate record, firms have the 
option under this rule to keep the original complaint along with a 
record of the disposition of the complaint, if kept by name of 
associated person. This rule does not limit a broker-dealer's

[[Page 55823]]

responsibilities under SRO and other regulations that may require 
creation and maintenance of records regarding, or reporting of, oral 
complaints.
---------------------------------------------------------------------------

    \45\ This paragraph was proposed as paragraph (a)(17) of Rule 
17a-3.
    \46\ This requirement is in addition to other recordkeeping 
requirements such as Rule 17a-4(b)(4), which requires firms to keep 
originals of all correspondence received. For example, if a broker-
dealer firm received a written complaint regarding the firm itself, 
the firm would be required to keep that complaint under Rule 17a-
4(b)(4). If the complaint related to a particular associated person, 
the firm would also be required to make a record of the complaint as 
to that associated person under Rule 17a-3(a)(18); however, the firm 
may keep one copy of the complaint to satisfy both Rules 17a-
3(a)(18)(i) and 17a-4(b)(4).
    \47\ See 17 CFR 240.17a-4(b)(4), and NASD Rule 3110(d).
---------------------------------------------------------------------------

    Paragraph (ii) of Rule 17a-3(a)(18) requires firms to make a record 
indicating that each customer has been provided with a notice of the 
address and telephone number of the department of the firm to which any 
complaints may be directed.\48\ This will assist both customers and 
broker-dealers to ensure that complaints reach the proper person or 
department so they can be recorded, reported (if necessary), and 
answered. Some commenters requested clarification of whether, in an 
introducing/clearing relationship,\49\ the contact information should 
be that of the introducing firm, the clearing firm, or both. To the 
extent not otherwise required, this should be a matter of negotiation 
between the introducing firm and the clearing firm.\50\ If contact 
information is provided for both firms, the notification should clearly 
indicate which firm the customer should contact and for what purposes. 
Two other commenters requested clarification as to whether this 
notification could take the form of a notice on customer 
statements.\51\ The Commission believes that firms should have 
flexibility as to how they may deliver this notice to customers, and 
inserting the notice on a customer statement is one acceptable 
alternative.
---------------------------------------------------------------------------

    \48\ This requirement expands 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 firm to qualify as an introducing firm 
with a lesser net capital requirement than a clearing firm, its 
customers must be treated as customers of the clearing firm. In 
addition, 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.
    \49\ See, e.g., Comment Letter from Lawrence M. Lowman, p. 1.
    \50\ See supra note 48; Exchange Act Release No. 31511 at note 
21 and accompanying text, (Nov. 24, 1992), 57 FR 56973 (Dec. 2, 
1992).
    \51\ See Comment Letters from the Discount Brokers, p. 7, and 
Donaldson, Lufkin & Jenrette, p. 10.
---------------------------------------------------------------------------

E. Compensation

    Paragraph (a)(19)(i) of Rule 17a-3 requires firms to make a record 
as to each associated person listing each purchase and sale of a 
security \52\ attributable, for compensation purposes, to that 
associated person. Again, the purpose for this requirement is to allow 
securities regulators to quickly identify compensation trends and focus 
examinations. The record must include the amount of compensation (if 
monetary) and a description of the compensation (if non-monetary). 
Under this requirement, firms must make records of all commissions, 
concessions, overrides, and other compensation to the extent they are 
earned or accrued for transactions. In addition, if the compensation is 
non-monetary, that description should include an estimate of its value.
---------------------------------------------------------------------------

    \52\ The phrase ``and the specific security,'' which appeared in 
the Reproposing Release, was not included in the Rule as adopted 
because it is redundant. The record ``listing all purchases and 
sales of securities for which the associated person was 
compensated'' must provide enough information to identify that 
purchase or sale to which the compensation was attributable.
---------------------------------------------------------------------------

    The term ``non-monetary compensation'' includes compensation such 
as sales incentives, gifts, or trips that would be provided to 
associated persons if certain sales goals were achieved. Such non-
monetary compensation should be recorded if directly related to sales. 
If sales would be counted toward achieving these goals, then a notation 
of the sales should be made regardless of whether that goal is actually 
achieved. Non-monetary compensation does not include items of little 
value distributed by the firm.
    Paragraph (ii) of new Rule 17a-3(a)(19) \53\ requires that firms 
maintain a record of all agreements pertaining to the relationship 
between each associated person and the broker-dealer, including a 
summary of each associated person's compensation arrangement or plan. 
Further, to the extent that compensation is based on factors other than 
remuneration on a per trade basis, the firm must make a record that 
describes the method by which compensation is to be determined.
---------------------------------------------------------------------------

    \53\ This Rule was reproposed as Rule 17a-3(a)(12)(ii) and Rule 
17a-3(a)(12)(iii).
---------------------------------------------------------------------------

    It should be noted that the requirement under paragraph (ii) that a 
broker-dealer maintain a record of all agreements between itself and 
each associated person includes verbal agreements and records, such as 
commission schedules, which may change on a periodic basis.
    The term ``relationship,'' as used in paragraph (a)(19) of Rule 
17a-3, solely refers to the employment or contractual relationship 
between the associated person and the broker-dealer. It would not 
relate to personal relationships unrelated to the firm's business.

F. Compliance With Requirements for Communications With the Public

    New paragraph (a)(20) of Rule 17a-3 \54\ requires each firm to make 
a record documenting that the firm has complied with, or adopted 
policies and procedures reasonably designed to establish compliance 
with, applicable federal regulations and SRO rules which require that a 
principal approve any advertisements, sales literature, or other 
communications with the public.\55\ This paragraph would apply to 
marketing materials, sales scripts, and other paper or electronic 
material, such as audio or video tapes, used by broker-dealers in 
communicating with the public. This paragraph, which is designed to 
allow State Securities Regulators to examine broker-dealers for 
compliance with SRO rules relating to communications with the public, 
does not establish a new source of supervisory responsibility. In 
addition, a broker-dealer has many options as to how it may create this 
record.\56\
---------------------------------------------------------------------------

    \54\ This paragraph was reproposed as paragraph (a)(19) of Rule 
17a-3.
    \55\ See e.g., NASD Rule 2210(b) and NYSE Rule 472.
    \56\ E.g., the record may consist of a principal's signature or 
initials on the communication, or a signed memo from the principal 
granting permission for use of the communication. Further, a firm 
may have policies and procedures designed to establish compliance 
with applicable federal regulations and SRO rules which require that 
a principal approve any advertisements, sales literature, or other 
communications with the public. Thus, records presently used to 
evidence compliance with SRO rules may also be used to fulfill this 
requirement.
---------------------------------------------------------------------------

    The Commission did not adopt the portion of this rule as reproposed 
that referenced specific types of advertisements or sales literature. 
Instead, the Commission will defer to SRO rules as to which 
communications with the public must be approved by a principal of the 
firm.

G. Persons To Explain Records and Their Content

    Paragraph (a)(21) of Rule 17a-3 requires a record listing, by name 
or title, all personnel at an office who, without delay, can explain 
the types of records the firm maintains at that office, and the 
information contained in those records. Commenters, particularly the 
States, indicated that this requirement is important because 
recordkeeping practices typically vary from firm to firm in ways 
ranging from format and presentation to the name of a record. 
Therefore, each firm must be able to promptly explain how it makes, 
keeps, and titles its records. To comply with this rule, a firm may 
identify more than one person and list which records each person is 
able to explain.
    Because it may be burdensome for firms to keep this record current 
if it lists each person by name, a firm may satisfy this requirement by 
recording the

[[Page 55824]]

persons capable of explaining the firm's records by either name or 
title.

H. Record Listing Principals of the Firm

    New paragraph (a)(22) of Rule 17a-3 requires firms to make a record 
listing each principal of the firm responsible for establishing 
policies and procedures reasonably designed to ensure compliance with 
any applicable securities regulatory authority requirements that 
require acceptance or approval of a record by a principal. This 
requirement is unchanged from the reproposal, and is intended to assist 
securities regulators by identifying individuals responsible for 
designing a broker-dealer's compliance procedures and managing the 
firm.

I. Definition of Principal

    Paragraph 17a-3(g)(2) defines the term ``principal'' to include any 
individual registered with a registered national securities association 
as a principal or branch manager of a member, broker or dealer, or any 
other person who has been delegated supervisory responsibility for the 
firm or its associated persons. By including any person who has been 
delegated supervisory responsibility in the definition of the term 
``principal,'' the rule has been modified from the reproposal to 
include the definitions of ``principal'' used by other securities 
regulatory authorities.

J. Definition of Securities Regulatory Authority

    The definition of ``securities regulatory authority'' in paragraph 
(g)(3) of Rule 17a-3 is substantially similar to that in the 
Reproposing Release, except that State Securities Regulators are 
identified as ``the securities commissions (or any agency or office 
performing like functions) of the States * * *'' \57\ mirroring the 
language that Congress used in NSMIA.
---------------------------------------------------------------------------

    \57\ Supra note 7.
---------------------------------------------------------------------------

K. Miscellaneous

    The Commission has not adopted reproposed paragraph (a)(20) of Rule 
17a-3, which would have required firms to make a record as to each 
associated person listing chronologically all customer purchase or sale 
transactions for which the associated person entered the order or was 
primarily responsible. Commenters stated that the information required 
in this record would already be maintained in other records, although 
not necessarily in the chronological format that this paragraph would 
have required. The Commission also has not adopted reproposed paragraph 
(a)(23) of Rule 17a-3, which would have required a firm to make a 
record listing each office of the firm and whether that office had been 
designated as a State record depository, since firms need no longer 
designate a State record depository for any purpose. This proposed 
record also would have required firms to list each associated person 
working out of or storing records at each office. The Commission has 
not adopted this requirement because firms are required to make a 
record of similar information under new paragraph (ii) of Rule 17a-
3(a)(12).\58\
---------------------------------------------------------------------------

    \58\ New paragraph (a)(12)(ii) of Rule 17a-3 requires firms to 
make a record showing, for each associated person, every office 
where the associated person regularly conducts a securities business 
and certain other information.
---------------------------------------------------------------------------

IV. Office Records

    The Reproposing Release would have required that broker-dealers 
make certain records for each local office and maintain copies of those 
records at the office to which the records relate. These requirements 
were designed to assist securities regulators when conducting sales 
practice examinations at particular offices. The Commission has adopted 
the requirements regarding the creation of these records substantially 
as reproposed, but has materially altered the alternatives for 
maintenance of those records.
    Generally, State Securities Regulators supported a requirement that 
records as to a particular office be maintained at that office, even if 
only electronically. The State Securities Regulators stated, in their 
comment letters, that they had encountered excessive and costly delays 
when conducting examinations when records were kept at another office. 
In sum, they stated that although firms generally had the records 
available in local offices, the firms preferred to funnel all records 
requested by examiners through their centralized compliance departments 
in order to assure accuracy, anticipate any potential violations, 
review material for applicable privileges, and make a record of 
documents reviewed by regulators.\59\ While the State regulators have 
the power to impose fines and penalties on firms that fail to timely 
produce records, the delays still result in unnecessary, wasted 
examination time at firms waiting for the records production. The delay 
is costly for regulators, particularly when they travel to remote areas 
to conduct surprise examinations at an office where they may spend 
numerous days awaiting the records.\60\
---------------------------------------------------------------------------

    \59\ See Comment Letter from Citicorp, p. 3, ``RRs in all local 
offices would have to be trained to do a function outside their 
current job responsibilities, namely to review material for 
applicable privileges and make records of documents reviewed by 
regulators.''
    \60\ See, e.g., Comment Letters from Arkansas Securities 
Department, pp. 1-3; Department of Financial Institutions, 
Commonwealth of Kentucky, p. 6; and Securities Division, State of 
Rhode Island and Providence Plantations, p. 1.
---------------------------------------------------------------------------

    The broker-dealer commenters were strongly opposed to this 
requirement for two main reasons. First, they stated that the 
requirement to maintain copies of documents at all local offices would 
be costly and burdensome because they would need to create and maintain 
two sets of records. They stated that even with the flexibility of 
being able to maintain the records electronically, this requirement 
would be costly because many firms do not currently have computer 
systems capable of retaining and producing all the required records. 
Second, firms stated that maintaining records at all local offices 
would force them to decentralize their recordkeeping, which would 
potentially compromise their controls on recordkeeping and supervisory 
practices.
    Requiring records to be maintained at each local office was the 
requirement most seriously disputed by the firms. The reproposal has 
been altered to allow a firm, rather than to maintain records at an 
office, to produce the records promptly at the request of a 
representative of a securities regulatory authority at the office to 
which the records relate or at such other place as is agreed to by the 
representative. These alternative methods for complying with paragraph 
(k) of Rule 17a-4 were added in response to comments that the 
requirement, as reproposed, would have forced firms to decentralize 
their recordkeeping systems and would have compromised their internal 
controls and supervisory practices.\61\
---------------------------------------------------------------------------

    \61\ This does not relieve broker-dealers from any other Federal 
or SRO requirements to maintain records at office locations. See, 
e.g., NASD Rule 3110(d) which requires firms to keep at each Office 
of Supervisory Jurisdiction (defined at NASD Rule 3010(g)(1)), 
either a separate file of all written complaints of customers and 
action taken by the firm, or a separate record of such complaints 
and a clear reference to the files containing the correspondence 
connected with such complaint maintained in such office.
---------------------------------------------------------------------------

    The Commission believes that the amendments to Rules 17a-3 and 17a-
4 adopted today, which set forth, (i) the definition of ``office,'' 
(ii) what records must be created as to each office,\62\ and (iii) what 
records must be maintained at each office,\63\ address the concerns of 
both regulators and broker-dealers.
---------------------------------------------------------------------------

    \62\ 17 CFR 240.17a-3(f).
    \63\ 17 CFR 240.17a-4(k).

---------------------------------------------------------------------------

[[Page 55825]]

A. Definition of Office

    For both creation and maintenance of records, the definition of 
``office'' adopted by the Commission includes any location where an 
associated person regularly conducts business.\64\ However, an office 
would not include a customer's office that an associated person may 
visit on a regular basis.
---------------------------------------------------------------------------

    \64\ 17 CFR 240.17a-3(g)(1).
---------------------------------------------------------------------------

    The Commission has also addressed concerns that arise when an 
associated person's residence is an office. Rule 17a-4(k) states that a 
broker-dealer is not required to produce records at an office that is a 
private residence, provided that (i) only one associated person, or 
multiple associated persons who reside at that location and are members 
of the same immediate family,\65\ regularly conduct business at the 
office; (ii) the office is not held out to the public as an office; and 
(iii) neither customer funds nor securities are handled at that office. 
Instead, Rule 17a-4(k) allows a broker-dealer to either maintain those 
records at some other location within the same State as that office as 
the broker-dealer chooses, or to promptly produce those records at an 
agreed upon location.
---------------------------------------------------------------------------

    \65\ The term ``immediate family,'' as used in paragraph (k), 
should be interpreted to have the same meaning as it does in NASD 
IM-2110-1(l)(2).
---------------------------------------------------------------------------

    For purposes of paragraph (f) of Rule 17a-3 \66\ and paragraph (k) 
of Rule 17a-4,\67\ in circumstances where an associated person works 
out of multiple offices, such as bank circuit riders, a firm may treat 
all the locations where the associated person regularly works as a 
single office.\68\
---------------------------------------------------------------------------

    \66\ New paragraph (f) of Rule 17a-3 requires firms to make and 
keep current separately as to each office, the books and records 
required under various paragraphs in Rule 17a-3.
    \67\ New paragraph (k) of Rule 17a-4 requires firms to either 
keep certain records at each office or produce them at that office 
or at another agreeable location.
    \68\ Firms need not apply to or notify securities regulators as 
to which office it selects as the associated person's ``office.'' 
However, pursuant to paragraph (a)(12)(iii) of Rule 17a-3, the firm 
must identify the office as such.
---------------------------------------------------------------------------

B. Records ``As To'' Each Office

    New paragraph (f) of Rule 17a-3 requires firms to make and keep 
current, separately for each office, certain books and records that 
reflect the activities of the office.\69\ It should be noted that 75% 
of broker-dealers have reported that they have no branch locations.\70\ 
The definition of ``office'' may be broader and more inclusive than the 
definition of ``branch,'' however.
---------------------------------------------------------------------------

    \69\ The specific paragraphs of Rule 17a-3 that are included in 
this requirement are (a)(1), (a)(6), (a)(7), (a)(12), (a)(16), 
(a)(17), (a)(18), (a)(19), (a)(20), (a)(21), and (a)(22).
    \70\ Per Schedule 1 data filed by broker-dealers as of year-
ending December 31, 1998. Pursuant to 17 CFR 240.17a-10, Broker-
dealers are required to file Schedule 1, which requires the 
reporting of general information designed to measure certain 
economic and financial characteristics.
---------------------------------------------------------------------------

    The Commission removed the sentence, ``This requirement may be 
satisfied by demonstrating that the data is maintained in a system 
which is capable of promptly generating records for each office upon 
request'', because the requirement to either maintain the specified 
records at each location or produce them on the same day a request is 
made has been changed to allow firms to produce these records promptly.

C. Records To Be Maintained at Office Locations

    There have been two major changes to new paragraph (k) of Rule 17a-
4 from the reproposal. First, the requirement to maintain certain 
records at the office locations has been expanded from one year to two 
years. This was done to establish parity with the retention 
requirements for the separate sections as provided under paragraph (b) 
of Rule 17a-4.
    Second, under paragraph (k) of Rule 17a-4, if a broker-dealer does 
not maintain records at an office, but instead chooses to produce the 
records upon request, the broker-dealer must produce the records 
``promptly.''\71\ The word ``promptly'' has deliberately not been 
defined in the rule. Generally, requests for records which are readily 
available at the office (either on-site or electronically) should be 
filled on the day the request is made. If a request is unusually large 
or complex, then the firm should discuss with the regulator a mutually 
agreeable time-frame for production.\72\
---------------------------------------------------------------------------

    \71\ Supra note.
    \72\ Valid reasons for delays in producing the requested records 
do not include the need to send the records to the firm's compliance 
office for review prior to providing the records.
---------------------------------------------------------------------------

    Based on the foregoing, the Commission has not adopted the 
reproposed provision of Rule 17a-4(k) that would have allowed firms to 
maintain records at a State records depository in lieu of maintaining 
the records at the office to which the records relate.
    One commenter requested guidance on how this paragraph relates to a 
foreign office of a U.S. registered broker-dealer.\73\ Under paragraph 
(f) of Rule17a-3, a broker-dealer must make certain records for a 
foreign office; however, a broker-dealer is not required to maintain or 
produce those records at the foreign office under paragraph (k). 
Instead, those records would be maintained at the broker-dealer's main 
office.
---------------------------------------------------------------------------

    \73\ See Comment Letter from A.G. Edwards & Sons, Inc., p. 8.
---------------------------------------------------------------------------

V. Rule 17a-4

A. General Record Retention Requirements

    Paragraphs (a) and (b)(1) of Rule 17a-4 list certain records 
required under Rule 17a-3 that must be kept for six and three years, 
respectively. The amendments to these two paragraphs have been modified 
from the reproposal to remain consistent with the modifications to Rule 
17a-3.

B. Retention of Communications

    Paragraph (b)(4) of Rule 17a-4 previously required that each 
broker-dealer keep originals of all communications received and copies 
of all communications sent by the firm relating to its business as a 
broker-dealer, including inter-office memoranda and communications. 
With respect to memoranda, including e-mail messages, the Commission 
has stated that the content and audience of the message determine 
whether a copy must be preserved, regardless of whether the message was 
sent on paper or sent electronically.\74\ The amendments to this 
paragraph adopted today will require firms to retain communications 
that are subject to SRO rules regarding ``communications with the 
public'' (such as advertising) as well, a requirement reproposed 
separately as paragraph (b)(10) of Rule 17a-4. This requirement is 
designed to provide State Securities Regulators with the ability to 
access these public communications records so they can enforce their 
laws relating to the form and use of public communications.
---------------------------------------------------------------------------

    \74\ Exchange Act Release No. 38245 (Jan. 31, 1997), 62 FR 6469 
(Feb. 12, 1997).
---------------------------------------------------------------------------

    It should be noted that a written advertisement that is never 
released to the public would not be covered by this rule; however, a 
sales script that is used by an associated person when communicating 
with the public would be covered even if the script itself is not 
delivered to the public.
    The requirement, as reproposed, that ``any written procedures [a 
broker-dealer] uses for reviewing the communications received or sent'' 
has been moved to new paragraph (e)(7) of Rule 17a-4, which requires 
firms to keep all compliance, supervisory, and procedures manuals, 
including any written procedures for reviewing communications.

[[Page 55826]]

C. Organizational Documents

    The Commission has modified paragraph (d) of Rule 17a-4, which 
require a broker-dealer to maintain certain organizational records. 
Specifically, the Commission has added language to clarify that 
organizational records of legal entities not specifically delineated in 
the present rule \75\ are still required to be preserved under this 
rule. Various State statutes use different terms to describe the legal 
entities that may be created under their rules and the organizational 
documents necessary to create those entities; accordingly, the 
Commission has included in this paragraph generic terms to describe the 
types of records that firms must keep. The Commission believes that 
generally broker-dealers that are not formed as corporations or 
partnerships are already keeping these types of records and that this 
amendment codifies current business practices. Similar to the amendment 
to paragraph (g)(3) of Rule 17a-3 noted above, the Commission has 
replaced the phrase ``state securities jurisdictions and self-
regulatory organizations'' in the Reproposing Release with the term 
``securities regulatory authorities.''
---------------------------------------------------------------------------

    \75\ For instance, limited liability companies (``LLCs'') would 
be covered.
---------------------------------------------------------------------------

    Under this paragraph, every broker-dealer is also required to 
maintain copies of its Form BD and all amendments thereto. To comply 
with this requirement with respect to amendments to Form BD, a broker-
dealer is required to retain a copy of only those portions of the Form 
that were amended. The Commission believes that generally broker-
dealers are already keeping these records and that this amendment 
codifies current business practices.

D. Account Record Information

    New paragraph (e)(5) of Rule 17a-4 requires broker-dealers to 
retain account record information for six years. The six-year period 
begins either at the time the account is closed or when the information 
is replaced or updated. This provision will allow regulators to review 
account record information for at least the six years immediately prior 
to the examination or investigation. Broker-dealers generally maintain 
account record information for at least the life of the account to 
facilitate a number of business purposes, including suitability 
determinations and supervision of accounts and representatives.

E. Special Reports

    New paragraph (e)(6) of Rule 17a-4 requires a firm to keep for 
three years a copy of all reports that a securities regulatory 
authority has requested or required a specific firm to create. Such 
special reports would include those reports that are requested or 
required under an order or settlement that requires the firm to produce 
the report as part of the terms of the order or settlement. The purpose 
of this paragraph is to clarify that these records must be kept and to 
provide guidance as to how long firms are expected to maintain these 
records.
    This requirement is not designed to limit the ability of securities 
regulatory authorities to obtain records that are otherwise required to 
be created and maintained, such as records of internal communications 
required to be maintained under paragraph (b)(4) of Rule 17a-4.

F. Compliance, Supervisory and Procedure Manuals

    The Commission is also adopting, as reproposed, new paragraph 
(e)(7) of Rule 17a-4. This paragraph requires firms to retain a copy of 
all compliance, supervisory, and procedures manuals describing the 
firm's policies and practices with respect to compliance and 
supervision, as currently in use and for three years after the 
termination of the use of each manual, including any updates, 
modifications, and revisions to the manuals. This will ensure that 
securities regulators are able to obtain information as to what 
policies and procedures were in place at a given time.

G. Exception Reports

    New paragraph (e)(8)(ii) of Rule 17a-4 requires firms to maintain 
copies of reports produced to review for unusual activity in customer 
accounts (commonly referred to as ``exception reports''). This 
paragraph does not obligate broker-dealers to create exception reports. 
Exception reports would include 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. These reports will help 
securities regulators discover sales practice problems such as 
churning, unauthorized trading, or other indications of micro-cap 
fraud, and will also provide securities regulators with information as 
to what type of data may have been available to the broker-dealer.
    In lieu of retaining copies of the reports, a member, broker or 
dealer may choose to promptly re-create the reports upon request by a 
securities regulatory authority. If the broker-dealer elects to re-
create exception reports instead of maintaining a copy of the report, 
but the firm has changed its systems so that it cannot re-create the 
same report, the broker-dealer may provide a copy of the report in the 
format presently available using historical data,\76\ but must also 
provide a record explaining each system change that affected each 
report.\77\ Lastly, if the firm is unable to re-create the report in 
any format for the most recent 18 months, due to changes, for example, 
in a database, software, or physical system, the rule provides that the 
broker-dealer may instead provide a record of the parameters that were 
used to generate the report for the time period specified by the 
representative of the securities regulatory authority. The Commission 
provided these alternatives in order to make this rule less burdensome 
on broker-dealers.
---------------------------------------------------------------------------

    \76\ For example, if the original report includes customer name, 
account number, social security number, and transactional 
information, however the report that can be re-created at a later 
date does not include social security numbers, the firm should 
provide the re-created report to the regulator with an explanation 
that although social security numbers appeared on the original 
report, the firm is unable to re-create the report including that 
information.
    \77\ This includes changes to hardware, software, or changes to 
the database used to produce the exception reports.
---------------------------------------------------------------------------

    Many firms commented that this requirement would be potentially 
counter-productive because, if firms are required to retain copies of 
all reports that they create, they would create fewer reports. However, 
the Commission believes that broker-dealers will continue to create 
those exception reports that are necessary to adequately supervise 
their business, and that retaining these reports will increase the 
efficiency of examinations by regulators and may reduce the examination 
burden on broker-dealers.

VI. Effective Date

    The final rules adopted today shall become effective May 2, 2003.

VII. Technical Amendments

A. Electronic Storage Media

    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.\78\ The Commission proposed and is now 
adopting technical amendments to that rule.\79\ The

[[Page 55827]]

Electronic Storage Media Release requires a broker-dealer that employs 
micrographic or electronic storage media to be ready at all times to 
immediately provide a facsimile enlargement upon request by the 
Commission or its representatives.\80\ It also requires a broker-dealer 
that exclusively uses electronic storage media to fulfill some or all 
of its record preservation requirements to contract with a third party 
download provider that will file undertakings with the broker-dealer's 
designated examining authority indicating that the download provider 
will furnish promptly to the Commission, its designees or 
representatives, the information necessary to download information kept 
on the broker-dealer's electronic storage media.\81\ 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 adopting these technical 
amendments to provide them with access to these records. The Commission 
is also adopting these technical amendments so that when broker-dealers 
use the undertaking option under Regulation ATS, SROs and State 
Securities Regulators will have access to those records.\82\
---------------------------------------------------------------------------

    \78\ Exchange Act Release No. 38245 (Feb. 5, 1997), 62 FR 6469 
(Feb. 12, 1997) (``Electronic Storage Media Release'').
    \79\ 17 CFR 240.17a-4(f).
    \80\ See 17 CFR 240.17a-4(f)(3)(i).
    \81\ See 17 CFR 240.17a-4(f)(3)(vii).
    \82\ Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR 70844 
(Dec. 22, 1998).
---------------------------------------------------------------------------

B. Other Technical Amendments

    The Commission is adopting amendments to Rule 17a-3(a)(12)(i) to 
update the list of stock exchanges for which an associated person's 
application for registration or approval may be used to satisfy the 
requirements under that paragraph. This amendment is a codification of 
current practices. The Commission is also adopting amendments to the 
language throughout Rules 17a-3 and 17a-4 that eliminate masculine 
references, and replace them with gender neutral references.

VIII. Costs and Benefits of the Amendments

    In the Reproposing Release, the Commission requested comment on the 
costs and benefits associated with the reproposed rules and rule 
amendments.\83\ Of the comments received by the Commission, fifty-seven 
commenters discussed the benefits and costs associated with the 
reproposal. Of those commenters, thirty were broker-dealers,\84\ 
twenty-two were States,\85\ two were consumer groups,\86\ two were 
other groups,\87\ and one was an individual.\88\ Most of the commenters 
(including all of the broker-dealer commenters) argued that the costs 
outweighed the benefits of the reproposed amendments and that the cost 
estimates provided in the Reproposing Release were too low. Although 
most of those arguments were general in nature, twenty-three commenters 
specifically referenced paragraph (a)(17)(i) of Rule 17a-3,\89\ and 
fifteen commenters specifically referenced paragraph (k) of Rule 17a-
4.\90\ All the States and the consumer groups that commented argued 
that most broker-dealers presently maintained most, if not all, the 
records required under the reproposed amendments, and that the 
benefits, although difficult to quantify, justified any costs which 
might be incurred.
---------------------------------------------------------------------------

    \83\ See supra note 9, at p. 54411.
    \84\ See Comment Letters from Mutual Service Corporation, p. 6; 
Titan Value Equities Group, Inc., pp. 2 and 4; USAA, pp. 2 and 6; 
MetLife, p. 4; A.G. Edwards and Sons, Inc., p. 6; MONY, p. 4; 
Capital West, p. 2; Comerica Securities, p. 2; Nationwide Investment 
Services Corporation, p. 2; Edward Jones, pp. 1 and 3; Advest, p. 1; 
Salomon Smith Barney, pp. 1 to 2; NyLife Securities, pp. 6 to 7; HD 
Vest, p. 2; American Express Financial Advisors, pp. 2 to 5; First 
Union, pp. 3 to 4; Charles Schwab, pp. 3 to 4; MML Investors 
Services, Inc., pp. 2 to 4; National Planning Corporation, p. 1; 
Pumphrey Securities, p. 2; Citicorp Investment Services, pp. 2 to 3; 
Discount Brokers, pp. 4 to 5; M & T Securities, pp. 1 and 2; 
Donaldson, Lufkin & Jenrette, p. 6; Investment Management & 
Research, Inc., p. 4; John Hancock Distributors, Inc., pp. 3 to 4; 
Southwest Securities, p. 2; the Securities Industry Association, p. 
10; Merrill Lynch, pp. 1, 6 to 7, and 11; and Raymond James, p. 5.
    \85\ See Comment Letters from Michigan, pp. 1 to 2; Idaho, pp. 1 
and 4; Kansas, pp. 1 to 2; Delaware, pp. 1 to 2; Colorado, p. 2; 
North Dakota, p. 1; Ohio, p. 1; Texas, pp. 1, 2 to 3, and 6; Hawaii, 
pp. 1 to 2; Rhode Island, pp. 1 to 2; New Hampshire, pp. 1 and 2; 
Nebraska, p. 1; Utah, pp. 1 and 3; NASAA, pp. 3 to 5 and 22; New 
York, pp. 1 and 3; Virginia, pp. 1 to 3; New Jersey, pp. 2 to 7; 
Washington, pp. 2 and 6; Arkansas, pp. 1, 3, and 5; New Mexico, p. 
1; North Carolina, pp. 1 to 2; and Montana, pp. 1, and 3 to 5.
    \86\ See Comment Letters from AARP, p. 2; and the Consumer 
Federation of America, pp. 2 to 3.
    \87\ See Comment Letters from American Council of Life 
Insurance, pp. 12 to 13; and International Association of Financial 
Planning, p. 6.
    \88\ See Comment Letter from Thomas Koutris, p. 1.
    \89\ This paragraph provides that broker-dealers must obtain 
certain information relating to the accounts of natural customers, 
and that customer account records must be updated regularly.
    \90\ In the reproposed rule this paragraph provided that certain 
records had to be maintained at the local office, or that they had 
to be produced at the local office to which they related on the same 
day a request for those records was made by a representative of a 
securities regulatory authority.
---------------------------------------------------------------------------

    One commenter stated that well-organized firms are less likely to 
experience the potentially catastrophic losses that result from serious 
securities violations.\91\ Many State Securities Regulators indicated 
in their comment letters that their agencies generally found that firms 
with inadequate books and records were more likely to have other 
problems, such as inadequate supervisory systems and selling-away 
issues. According to the NASD's Office of Dispute Resolution, $126 
million and $76 million were awarded by NASD arbitrators in 1999 and 
2000 respectively in customer claimant cases, of which $48 million and 
$21 million respectively constituted punitive damages.\92\ The vast 
majority of claims filed for arbitration with the NASD's Office of 
Dispute Resolution during this time period related to sales practice 
issues. In addition, two industry participants estimated that they 
presently pay outside counsel approximately $50 million and $25 million 
respectively each year to deal with sales practice complaints.\93\
---------------------------------------------------------------------------

    \91\ See Comment Letter from State of Virginia, pp. 1 to 3.
    \92\ Per NASD Dispute Resolution, Inc. website: 
www.nasdradr.com/statistics.asp.
    \93\ It should be noted that these estimates do not include any 
internal compliance, operational, and/or legal costs incurred by 
these firms in dealing with these complaints.
---------------------------------------------------------------------------

    Many States indicated that they believed the amendments would 
impose only minimal additional costs to broker-dealers because, in 
their experience, many broker-dealers already maintain the records 
required by the amendments in order to comply with SRO rules, State 
laws that applied prior to NSMIA, or simply to properly manage costs 
and supervise offices. Further, some States indicated that they 
believed that broker-dealers were exaggerating the potential costs of 
the reproposed amendments.\94\
---------------------------------------------------------------------------

    \94\ See, e.g., Comment Letter from the State of New Jersey, p. 
5.
---------------------------------------------------------------------------

    In fact, the States of Connecticut \95\ and Florida \96\ conducted 
special reviews, in conjunction with their examination programs, to 
determine the extent to which broker-dealers already maintained the 
records required under the Reproposal at office locations. The State of 
Connecticut concluded that its review ``overwhelmingly indicate[d] that 
all the books and records that would be required by the re-proposed

[[Page 55828]]

rule proposal are, at the present time, being maintained in offices 
within Connecticut and similarly outside the state.'' Further, 
Connecticut stated, ``During this review process the records were 
immediately available for inspection upon request,'' and ``the types of 
records required by the reproposed rule would not be burdensome in that 
the firms retained substantially more records than required.'' 
Connecticut also stated, ``[t]he retention schedules listed in the 
firms' compliance [manuals] were consistent with the requirements under 
the reproposed rule.'' Florida stated, ``[t]he reviews indicated that 
based on records maintained most branch offices met or exceeded the 
records requirement for the [re-]proposed rule, and ``[a] vast majority 
of the branch offices maintained the records on-site for periods of at 
least 2 years (and in some cases up to 6 years).'' Further, Connecticut 
stated, ``[t]he firms' recordkeeping requirements did not vary from 
location to location or even state to state because they were required 
by the firms' own compliance manuals,'' and ``[i]n certain instances, 
the firms' compliance manuals indicated that these additional records 
were necessary to adequately supervise its branch operations.'' 
Similarly, Florida stated, ``[m]anagement of several firms visited 
reported that record creation and retention is a nationwide 
requirement; the same for all offices in all states, not specific to 
the state of Florida * * * [t]his information was verified by the 
firms' Operational/Supervisory Compliance Manuals.''
---------------------------------------------------------------------------

    \95\ See Second Comment Letter from State of Connecticut. The 
State of Connecticut performed examinations of forty-nine office 
locations of twenty-three broker-dealers in five States. Seventeen 
of these offices had two or less associated persons working there. 
In addition, the State reviewed the most recent 100 examinations it 
had performed, and as well as investigatory materials from the prior 
two years wherein subpoenas were issued to obtain broker-dealer 
records.
    \96\ See Second Comment Letter from NASAA. The State of Florida 
performed examinations on 19 broker-dealers.
---------------------------------------------------------------------------

    A number of the States contend that investors are defrauded of 
millions and millions of dollars every year as a result of sales 
practice violations by broker-dealers.\97\ Further, Commission staff 
found through ``The Large Firm Project'' \98\ ``25% of the branch 
office examinations conducted in this project resulted in referrals for 
enforcement investigation and possible disciplinary action,'' and 
``[t]he examinations also revealed that some branch office managers 
were not implementing firm procedures adequately,'' and recommended 
that ``the Commission should develop better means of identifying sales 
practice problems.'' \99\ The enhanced recordkeeping requirements would 
help make available critical information necessary for securities 
regulatory authorities to discover and take appropriate action for 
various securities violations, particularly sales practice violations. 
The cost to securities regulatory authorities to obtain the same 
information and evidence that otherwise would be available by these 
rules from other methods would be high. In addition, the possibility 
exists that government regulatory authorities would be unable to obtain 
certain information by any other means if the information is not 
required to be kept. Investigatory delays often lead to additional 
investor losses. The State of New Jersey contended that these delays 
could lead to an erosion of public confidence in the industry, which 
can be exacerbated by the public's belief that securities regulatory 
authorities lack the ability to properly oversee broker-dealers and 
enforce securities regulations.\100\ NASAA commented that lack of 
public confidence in the marketplace can lead to an inability of 
issuers to raise capital.\101\
---------------------------------------------------------------------------

    \97\ Four States provided specific information regarding 
investor losses. Illinois indicated (in its Comment Letter, p. 2) 
that over the past 8 years, 29 enforcement cases were brought in 
which Illinois investors lost over $38.9 million dollars. Kansas 
indicated (in the attachment to its Comment Letter) that, with 
respect to cases they have brought over the past ten years, Kansas 
customers have lost over $6.4 million dollars. Ohio indicated (in 
its Comment Letter, p. 3) that in one particular case Ohio investors 
lost over $60 million dollars. Lastly, Connecticut indicated (in its 
Comment letter, p. 2) that, with respect to cases they have brought 
where the investors' relationship was established through small 
offices, Connecticut investors have lost over $12 million.
    \98\ Report by the Division of Market Regulation and the 
Division of Enforcement, U.S. Securities and Exchange Commission, 
The Large Firm Project: A Review of Hiring, Retention and 
Supervisory Practices (May 1994).
    \99\ Id., at pp. 5 and 7.
    \100\ See, Comment Letter from the State of New Jersey, p. 3.
    \101\ See, Comment Letter from NASAA, pp. 7-8.
---------------------------------------------------------------------------

    Most broker-dealer commenters indicated that two of the reproposed 
amendments would cause them to incur substantial additional costs. 
These two amendments were paragraph (k) of Rule 17a-4, which required 
that records be maintained at local offices or that firms produce those 
records at the local office on the same day a request for records was 
made by a regulator at that local office, and paragraph (a)(17)(i) of 
Rule 17a-3, which required that a broker-dealer provide customers with 
a copy of their account record at specified times. As a result of 
comments received in response to the Reproposing Release, the 
Commission substantially modified those two amendments as described 
above.
    The only other paragraphs broker-dealers specifically identified as 
resulting in increased costs were (a)(6) and (a)(7) of Rule 17a-3, 
which require that brokerage order tickets include the time of receipt, 
and that dealer order tickets include a notation of any modifications 
to an order. The Commission addressed some of these comments by 
modifying paragraph (a)(6) to provide an exemption for mutual fund and 
variable contract orders processed on a subscription-way basis. 
Further, for certain securities, the receipt time and notation of 
modification are already required under SRO rules.\102\ The only cost 
to firms resulting from these paragraphs relate to assuring that 
processes for recording this information will record the information 
for all orders that are not exempt and not just those orders covered by 
SRO rules.
---------------------------------------------------------------------------

    \102\ E.g., the NASD's OATS rules, and NYSE rules 123 and 410A.
---------------------------------------------------------------------------

    A few commenters attempted to provide alternative cost estimates 
for use in calculating the costs of the amendments. Some firms provided 
specific numbers, but provided no explanation as to the source of their 
estimates or their reason for believing that they would be more 
accurate than the Commission's estimates. In addition, certain costs 
are no longer relevant because the Commission substantially modified 
the amendments in response to comments. Accordingly, after 
consideration of all of the circumstances, the Commission has altered 
its cost estimates to reflect the fact that changes were made to the 
amendments in response to the comments received. Further, where the 
amendments were not altered significantly, the Commission has 
substantially increased estimates of costs that commenters argued were 
significantly underestimated.
    The Commission estimates that the aggregate cost of these 
amendments will be approximately between $78.2 million and $84.3 
million in the first year, and between $52.5 and $58.6 million per year 
thereafter (depending on what estimated postage cost is included in the 
calculations). Dollar costs relating to specific amendments are 
detailed below.
    For purposes of this cost-benefit analysis, the amendments to Rules 
17a-3 and 17a-4 are divided into three groups: (i) Those pertaining to 
the maintenance of office records and alternatives to these 
requirements; (ii) those pertaining to the periodic updating of 
customer information; and (iii) all other new requirements covered by 
the amendments.

A. Changes To Rule 17a-4, Including Maintenance of Office Records and 
Alternatives To These Requirements

    As amended, Rule 17a-4 requires broker-dealers to maintain certain

[[Page 55829]]

records at each office. As discussed above, new Rule 17a-4(k) was 
modified from the reproposal to provide broker-dealers with the 
alternative of ``promptly'' producing certain records pertaining to a 
particular office at that office or at a mutually agreeable alternative 
location. This modification should significantly reduce the compliance 
costs associated with the amendments.
    The amendments standardize the amount of time broker-dealers must 
maintain certain records, and may thereby increase the amount of time 
these records are kept by certain firms. Broker-dealers generally 
maintain these records already to comply with Federal laws or 
regulations, SRO rules, or in the normal course of business. These 
records include, (i) information relating to the principals responsible 
for reviewing and updating policies and procedures, (ii) copies of 
Forms BD, BDW and amendments thereto, (iii) copies of compliance, 
supervisory, and procedures manuals, (iv) customer account records, (v) 
order ticket information, (vi) records relating to compensation of 
associated persons, (vii) evidence of compliance with SRO advertising 
and sales literature rules, (viii) exception reports, and (ix) 
specialized reports produced pursuant to an order or settlement.
    The amendments will also standardize the type of records that must 
be kept by broker-dealers and the manner in which those records must be 
produced during examinations. Before NSMIA, States had various books 
and records requirements. Although these requirements were similar to 
Commission and SRO requirements, differences existed that broker-
dealers had to track and comply with. As one commenter stated, ``the 
cost savings to industry of moving from compliance in the pre-NSMIA 
days with a variety of State laws to a new uniform should be equally 
substantial and should more than make up for any [additional] burden 
imposed by the [amendments].'' \103\ The uniformity provided by NSMIA 
and these amendments to Rules 17a-3 and 17a-4 should result in 
significant cost savings to broker-dealers that operate in multiple 
jurisdictions.
---------------------------------------------------------------------------

    \103\ See, Comment Letter from the Consumer Federation of 
America, p. 3, note 4.
---------------------------------------------------------------------------

1. Benefits
    The amendments should result in increased efficiency and 
effectiveness of broker-dealer examinations, especially with respect to 
small offices. Increasing the efficiency of examinations tends to 
decrease the costs incurred by both regulators, whose staff spends time 
conducting examinations, and broker-dealers, whose personnel may be 
inconvenienced for the period the examiners are present in their 
offices. One State estimated that the average cost for them to perform 
an office examination was $1,300 to $1,500 per day.\104\ Another State 
suggested that a local office with well organized records normally 
takes 2 to 3 days to complete, but that an office with incomplete 
records takes an additional 2 or more days.\105\ While average costs 
and time periods may vary from State to State, their operations tend to 
be similar and the Commission expects the amendments to reduce the time 
and costs of State securities examinations. This will also allow 
regulators to identify abusive practices earlier during inspections and 
perform more targeted examinations. In addition, broker-dealers should 
benefit by having their operations interrupted for shorter time 
periods. Costs of examinations may also be further reduced due to the 
uniformity of the recordkeeping provided by the amendments, because 
regulators and broker-dealers will know what records the firms should 
have on hand.
---------------------------------------------------------------------------

    \104\ See Comment Letter from State of Michigan Department of 
Consumer & Industry Services, p. 1.
    \105\ See Comment Letter from State of Texas' State Securities 
Board, pp. 2-3.
---------------------------------------------------------------------------

2. Costs
    The amendments were drafted to permit flexible methods for the 
creation and maintenance of records in order to reduce the burdens on 
broker-dealers. This gives broker-dealers the flexibility to choose the 
least costly method to comply with the rules based upon their present 
processes and systems capabilities.
    The Commission believes that the amendments to Rule 17a-4 will not 
impose significant cost burdens because, in order to comply with 
federal laws or regulations, SRO rules, or in the normal course of 
business, broker-dealers already maintain most of the records specified 
in the amended rule. Similarly, broker-dealers already are required to 
provide regulators with books and records on demand. The Commission 
estimates that the amendments to Rule 17a-4 could result in additional 
costs for some broker-dealers who do not presently maintain certain 
items for the prescribed periods of time or in a manner where they can 
be easily segregated by office. On average, the Commission estimates 
these additional costs incurred by each broker-dealer to ensure 
compliance with the amendments to Rule 17a-4 to be approximately 
$405.00 \106\ per year, resulting in an overall cost to the industry of 
about $2.9 million per year.\107\
    Also, as mentioned previously, the State of Connecticut concluded 
in its study that, ``the types of records required by the re-proposed 
rule would not be burdensome in that the firms retained substantially 
more records than required.'' \108\
---------------------------------------------------------------------------

    \106\ The Commission estimates that these amendments to Rule 
17a-4 will take broker-dealers an additional four hours each per 
year. In the Reproposal the Commission estimated that these 
amendments would take an additional eight hours. Since the 
amendments being adopted today allow broker-dealers the option of 
not maintaining records at each office or producing records to the 
office to which they relate on the same day they are requested, the 
original estimate was reduced by one-half. The Commission believes 
that firms will have senior compliance personnel ensure compliance 
with these amended rules. According to the Securities Industry 
Association (``SIA'') Management and Professional Earnings 2000 
report, Table 051, the hourly cost of a Compliance Manager + 35% 
overhead is $101.25. ($101.25  x  4)=approximately $405.00 for each 
respondent, per year.
    \107\ ($405.00 per respondent  x  (7,217 broker-
dealers)=approximately $2.9 million per year.
    \108\ Supra at note 95 .
---------------------------------------------------------------------------

B. Periodic Updating of Customer Account Record Information

    Paragraph (a)(17) of Rule 17a-3 requires broker-dealers to obtain 
additional account record information. Present federal and SRO rules 
require that firms obtain and maintain that same information in many 
circumstances,\109\ and many broker-dealers presently obtain and 
maintain this information as a prudent business practice to avoid 
disputes with customers, or for other business reasons.
---------------------------------------------------------------------------

    \109\ 17 CFR 240.17a-3(a)(9), NASD Rules 2310(b), 3110(c) and 
IM-2860-2, and NYSE Rules 405, 407, 408, 410A, and 721.10.
---------------------------------------------------------------------------

    The amendments also require that broker-dealers send account record 
information \110\ to customers for verification within thirty days of 
account opening and at least every thirty-six months thereafter \111\ 
and to require that broker-dealers provide customers with certain 
account record information when changes are made.\112\

[[Page 55830]]

Many broker-dealers already send customers notification of address 
changes,\113\ and some also send a copy of a customer's new account 
form to the customer when an account is opened.\114\ While there is 
presently no requirement to send a copy of the customer account record 
at least once every 36 months to verify the information, broker-dealers 
are required to keep their records current.\115\
---------------------------------------------------------------------------

    \110\ Including customer name, address, telephone number, 
employment status, annual income, net worth, and the investment 
objectives for the account.
    \111\ The Commission originally proposed that broker-dealers 
verify customer account information at least once each year (See 
Proposing Release), however this was modified and reproposed as once 
every thirty-six months in the Reproposal based upon comments 
received from broker-dealers who contended that it would be too 
costly to send account information to customers yearly.
    \112\ Broker-dealers must furnish notification of a change in 
the name or address information to the customer's old address, and 
must furnish a copy of new account record information to the 
customer if some other information component is changed.
    \113\ See e.g., Comment Letter from Raymond James Financial, 
Inc., p. 4.
    \114\ See e.g., Comment Letter from Investment Management & 
Research, Inc., p. 4.
    \115\ Supra note 1.
---------------------------------------------------------------------------

1. Benefits
    The amendments should benefit broker-dealers by assuring that they 
have up-to-date information when making investment recommendations and 
reviewing suitability of certain transactions or investment strategies. 
Further, both broker-dealers and their customers will benefit by 
assuring that there is mutual understanding of the customer's financial 
position and objectives for the account. Indeed, requiring broker-
dealers to update customer account records may assist less well managed 
firms in better supervising their operations to identify potential 
problems before they lead to regulatory or legal exposure and monetary 
losses.
    Moreover, the amendments have been modified to exempt corporate 
accounts, inactive accounts, and accounts not requiring a determination 
of suitability. These changes reduce the total number of accounts 
covered by the updating requirements by over 25,000,000.\116\
---------------------------------------------------------------------------

    \116\ See infra note 117.
---------------------------------------------------------------------------

2. Costs
    The requirement to send account record information to customers 
will cause firms to incur costs to update their processes, and, with 
respect to the individual mailings, will add preparation expenses and 
additional postage charges. Further, firms will incur additional costs 
to update account information when customers notify the firm that their 
account record information has changed. Because broker-dealer 
processes, systems capabilities, and customer bases vary so widely, it 
is difficult to provide an estimated cost with which all parties will 
agree; however, the Commission estimates that for each of the 
23,500,000 accounts to which a copy of the account record must be sent 
each year,\117\ broker-dealers will spend an average of approximately 
3.28 minutes \118\ (including time for processing and any updating) 
costing between $1.36 and $1.62 per piece,\119\ including postage. Thus 
the aggregate cost of Rule 17a-3(a)(17) is estimated to be between $32 
million and $38.1 million (depending on what estimated postage cost is 
included in the calculations). In addition, the Commission estimates 
that all broker-dealers will, on average, incur a one-time cost of 
approximately $312.00 each \120\ to update their forms, resulting in an 
aggregate cost of approximately $2.25 million.
---------------------------------------------------------------------------

    \117\ Broker-dealers reported, in their 12/31/00 Schedule 1 
filings (required to be filed pursuant to 17 CFR 240.17a-10), that 
they maintained a total of 97,600,000 customer accounts. The 
Commission estimates that at least 27,100,000 of these accounts are 
excluded from the provisions of Rule 17a-3(a)(17) because they are 
either not accounts of natural persons, inactive, or accounts for 
which the broker-dealer does not have a suitability requirement (the 
Commission arrived at this number using estimates provided by the 
firms, in their comment letters and otherwise, as to how many of 
their accounts would fit into one or more of these categories. See 
Rule 17 CFR 240.17a-3(a)(17)(i)(D)). Accordingly, the total number 
of accounts which would need to be contacted for updating is 
70,500,000 every three years. 70,500,000/3 = 23,500,000 per year.
    \118\ Of the 23,500,000 accounts to which a copy of the account 
agreement must be sent each year, 22,975,000 (or 97%) of those 
accounts are attributable to 70 large broker-dealers which maintain 
over 100,000 customer accounts. Based upon the comment letters and 
other communications, large broker-dealers are more automated and 
small broker-dealers have more manual processes. The estimated 
additional time to send out customer account information is 1\1/2\ 
minutes per account for large broker-dealers and 7 minutes per 
account for small broker-dealers. The estimated number of customers 
who will provide updated account record information is 4,700,000 (or 
20% of customers to which notification is sent--this estimate is 
based on a comment letter sent by Merrill Lynch) (4,559,000 the 
4,700,000 are estimated to be maintained at large broker-dealers). 
The estimated time to update these account records is 5 minutes per 
account record for large broker-dealers and 10 minutes per account 
for small broker-dealers, and the estimated time to send updated 
account record to customer to notify of change is 1\1/2\ minutes for 
large broker-dealers and 7 minutes for small broker-dealers. The 
estimated number of customers who will change their account record 
without being prompted by a mailing is 3,525,000 (3,419,250 of which 
are maintained at large broker-dealers), and the estimated time to 
send updated account record information to those customers is 1\1/2\ 
minutes per account for large broker-dealers and 7 minutes per 
account for small broker-dealers. Thus it would take approximately 
2.25 minutes per account contacted each year to send account records 
(((22,795,000  x  1\1/2\) + (705,000  x  7)) + ((4,559,000  x  1\1/
2\) + (141,000  x  7)) + ((3,419,250  x  1\1/2\) + (105,750  x  
7)))/23,500,000 accounts contacted yearly. In addition, it would 
take approximately 1.03 minutes per account contacted each year to 
update the account records (((4,559,000  x  5) + (141,000  x  10))/
23,500,000 accounts contacted yearly. In total, the Staff estimates 
that it would take 3.28 minutes per account contacted each year for 
processing and any updating.
    \119\ The estimated total additional hours to provide customers 
with account record information is 880,369 hours ((((22,795,000  x  
1\1/2\) + (705,000  x  7)) + ((4,559,000  x  1\1/2\) + (141,000  x  
7)) + ((3,419,250  x  1\1/2\) + (105,750  x  7)))/60 minutes). The 
estimated total additional hours to update customers accounts is 
403,417 hours (((4,559,000  x  5) + (141,000  x  10))/60 minutes in 
an hour). The hourly wage of the average person who would be 
providing customers with account record information is $22.70 per 
hour (per the SIA Report on Office Salaries In the Securities 
Industry 2000, Table 082 (Retail Sales Assistant, Registered) and 
including 35% in overhead charges). The hourly wage of the average 
person who would be updating account record information is $25.90 
per hour (per the SIA Report on Office Salaries In the Securities 
Industry 2000, Table 086 (Data Entry Clerk, Senior) and including 
35% in overhead charges). Thus the aggregate cost of these hours is 
about $30.4 million ((880,369 hours  x  $22.70) + (403,417 hours  x  
$25.90)). The estimated additional cost of paper, printing, and 
postage to provide this information to customers is between $.05 and 
$.244 per record sent, or between $1.6 million and $7.7 million 
(($.05 or $.244)  x  (23,500,000 + 4,700,000 + 3,525,000)). Yielding 
a total cost per record sent of between $1.36 and $1.62 (($30.4 
million + ($1.6 million or $7.7 million))/23,500,000 records sent 
per year).
    \120\ It is estimated that it will take firms 2 hours each, on 
average, to update their forms to include information regarding the 
meaning of investment objective terms. The Commission believes that 
firms will have an attorney perform this task. According to the SIA 
Management and Professional Earnings 2000 report, Tables 107 
(Attorney) and 108 (Compliance Attorney), the hourly cost of an 
attorney + 35% overhead is $156.00 per hour. ($156.00  x  2) = 
approximately $312.00 per broker-dealer.
---------------------------------------------------------------------------

    As described more fully below, the Commission estimates that large 
broker-dealers (broker-dealers having over 100,000 accounts) will, on 
average, incur startup costs and ongoing costs to purchase and maintain 
additional equipment and develop systems of $.31 per account and $.25 
per account respectively. Based upon the comment letters,\121\ the 
Commission believes that the additional costs for smaller broker-
dealers is included in the hourly burden costs delineated above.
---------------------------------------------------------------------------

    \121\ One small broker-dealer stated, ``smaller firms lack the 
automation to do this type of action* * * without additional 
personnel,'' (See Comment Letter from Titan Value Equities Group, 
Inc., p. 2) another stated, ``[w]e do not have electronic account 
records,'' (See Comment Letter from Capital West Securities, Inc., 
p. 2) and another stated, ``for most firms [the] initial 
identification process would be manual'' and ``compiling the account 
record to send would require* * * pulling out a paper file for the 
account and making photo copies of the documents or pulling up the 
account on a computer system and printing out the required account 
information screens.'' (See Comment Letter from Comerica Securities, 
p. 2.) No smaller broker-dealer provided information regarding any 
increased equipment or systems development costs.
---------------------------------------------------------------------------

    Two large broker-dealers estimated the start-up costs of purchasing 
equipment and modifying systems to range from $1,000,000 \122\ to 
$1,300,000.\123\ These two firms had a total of approximately 7,500,000 
accounts which appeared to be subject

[[Page 55831]]

to the updating requirement. The start-up costs per account, based upon 
these figures, is approximately $0.31 (($1,000,000 + $1,300,000)/
7,500,000 accounts). It is important to note that the firms' estimates 
were based upon the assumption that they would have to update all of 
their accounts. Since the amendments adopted today provide an exemption 
for corporate accounts, inactive accounts, and accounts for which no 
suitability determination must be made, the actual costs will probably 
be much lower. These two firms further estimate that ongoing costs for 
equipment and systems development would range from $300,000 \124\ to 
about $1,600,000 \125\ per year. The ongoing costs per account would be 
$0.25 per account (($300,000 + $1,600,000)/7,500,000 accounts). 
Therefore, the total additional start-up and ongoing costs to obtain 
equipment and develop systems for these two large firms would be $0.56 
per account ($0.31 + $0.25).
---------------------------------------------------------------------------

    \122\ See Comment Letter from Morgan Stanley Dean Witter, p. 4.
    \123\ See Comment Letter from Merrill Lynch, p. 7 ($630,000 + 
$370,000 + $300,000).
    \124\ See Comment Letter from Dean Witter, p. 4.
    \125\ See Comment Letter from Merrill Lynch, p. 7. Merrill 
Lynch's estimate that they would spend $3.8 million for ongoing 
costs was reduced to account for the fact that the Commission has 
included costs to send account records to customers, costs to update 
customer account records, costs to send notification of updates to 
customers, and postage costs, which are included in Merrill's $3.8 
million figure, elsewhere.
---------------------------------------------------------------------------

    Of the 70,500,000 accounts, 68,385,000 (97%) belong to large 
broker-dealers that have more than 100,000 accounts, therefore the 
total start-up costs for large broker-dealers to purchase equipment and 
develop their systems is about $21.2 million (68,385,000  x  $0.31). 
Similarly, the ongoing equipment and systems development costs for 
large broker-dealers would be about $17.1 million per year (68,385,000 
x  $0.25).

C. Other New Requirements Covered by the Amendments

    Paragraphs (a)(12) and (a)(19) of Rule 17a-3 require broker-dealers 
to keep certain records regarding each associated person, including all 
agreements pertaining to the associated person's relationship with the 
broker-dealer and a summary of each associated person's compensation 
arrangement,\126\ a record delineating all identification numbers 
relating to each associated person,\127\ a record of the office at 
which each associated person regularly conducts business,\128\ and a 
record as to each associated person listing transactions for which that 
person will be compensated.\129\ The Commission believes that broker-
dealers generally create and maintain these records already under 
prudent recordkeeping procedures.\130\ The list of transactions for 
which each associated person will be compensated can be created at the 
time of an examination.
---------------------------------------------------------------------------

    \126\ 17 CFR 240.17a-3(a)(19)(ii).
    \127\ 17 CFR 240.17a-3(a)(12)(ii).
    \128\ 17 CFR 240.17a-3(a)(12)(iii).
    \129\ 17 CFR 240.17a-3(a)(19)(i).
    \130\ See supra text accompanying notes 95 and 96.
---------------------------------------------------------------------------

    Paragraph (a)(18) of Rule 17a-3 requires broker-dealers to keep a 
record relating to written customer complaints and maintain a record of 
whether customers were provided with an address where they should 
direct complaints. Firms may, instead of creating a separate record of 
complaints, simply maintain a copy of each complaint, along with a 
record of the disposition of the complaint.
    Paragraphs (a)(6) and (a)(7) of Rule 17a-3 have been amended to 
require that broker-dealers also record the identity of the associated 
person responsible for an account and the identity of the person who 
accepted the order, and whether the order was entered pursuant to 
discretionary authority. In addition, the amendment to paragraph (a)(6) 
requires that firms record the time an order was received from a 
customer, and the amendments to paragraph (a)(7) require that firms 
make a record of any modifications to an order. Paragraph (a)(6) now 
contains an exception providing that, for transactions done on a 
``subscription-way'' basis, where an application or subscription 
agreement is sent to the issuer in place of an order ticket, broker-
dealers may keep the application or subscription agreement in place of 
the order ticket. In addition, SRO rules already require that firms 
record and maintain certain of this information,\131\ and firms, to 
assist in their supervision of the activities of their associated 
persons and to assure that commissions are properly paid, already 
record the identity of persons as required under the amendments.
---------------------------------------------------------------------------

    \131\ See supra 102 note.
---------------------------------------------------------------------------

    The amendments also require broker-dealers to make records 
indicating that they have complied with applicable regulations of 
certain securities regulatory authorities,\132\ listing persons who can 
explain the information in the broker-dealer's records,\133\ and 
listing principals who are responsible for establishing compliance 
policies and procedures.\134\ The Commission believes that these 
amendments will cause broker-dealers to incur only minimal additional 
costs. Firms presently maintain records to evidence compliance with SRO 
and other rules, they presently maintain lists of principals or branch 
managers responsible for supervising each of their offices under other 
SRO rules, and they maintain lists of associated persons operating out 
of each office location. Firms must, as part of their supervisory 
system, identify principals responsible for reviewing the firm's 
procedures and taking action to achieve compliance with applicable 
securities laws, regulations and rules.\135\
---------------------------------------------------------------------------

    \132\ 17 CFR 240.17a-3(a)(17)(ii) and 17 CFR 240.17a-4(b)(4).
    \133\ 17 CFR 240.17a-3(a)(21).
    \134\ 17 CFR 240.17a-3(a)(22).
    \135\ See e.g., NASD Rule 3010.
---------------------------------------------------------------------------

1. Benefits
    The records required by these sections are either presently 
required under other federal laws or rules or SRO rules or currently 
maintained by many firms as a prudent business practice. These 
amendments codify current recordkeeping practices and make clear what 
records broker-dealers may be required to provide to State and other 
regulators. These records are expected to assist firms in better 
supervising their operations and identifying potential problems before 
they lead to regulatory or legal exposure and monetary losses.
2. Costs
    The Commission has endeavored to codify present broker-dealer 
business practices in these amendments and has adjusted the amendments 
based upon comments received in response to the Proposal and 
Reproposal, as discussed above. Thus, these amendments are not expected 
to change market or industry behavior significantly. For example, firms 
are presently required to maintain copies of all communications under 
Exchange Act Rule 17a-4(b)(4), and certain SRO rules require that 
members maintain copies of all written complaints and a record of the 
actions taken by the broker-dealer with respect to each complaint.\136\ 
Therefore, the Commission believes that amending Rule 17a-3 to require 
this information will not cause broker-dealers to incur any additional 
costs. Similarly, the Commission does not believe that the amendments 
to Rules 17a-3(a)(6) and 17a-3(a)(7) will cause any additional cost.
---------------------------------------------------------------------------

    \136\ See e.g., NASD Rule 3110(d), and for options complaints 
NASD Rule 2860(b)(17).
---------------------------------------------------------------------------

    Nevertheless, broker-dealers may incur costs in assuring that their 
present practices comply with the amendments. For example, the 
Commission believes that the requirement to provide customers with an 
address where they can send complaints will cause firms to incur a one-
time cost of approximately

[[Page 55832]]

$312.00 \137\ each, resulting in an aggregate cost of approximately 
$2.25 million. In addition, the Commission estimates that it will cost 
each firm an average of $50.83 per year to ensure compliance with 
paragraphs (a)(12) and (a)(19) of Rule 17a-3 (regarding associated 
person records),\138\ resulting in an aggregate cost of approximately 
$0.4 million per year. Finally, the Commission estimates that each firm 
will spend an average of approximately $16.88 per year to ensure 
compliance with other requirements,\139\ resulting in an aggregate cost 
of approximately $0.1 million per year.
---------------------------------------------------------------------------

    \137\ The Commission estimates that it will take each broker-
dealer, on average, two hours to update its forms to include the 
address to which complaints should be sent. This is a very 
conservative estimate, since it will probably take much less than 2 
hours to write down the broker-dealer's address and where it should 
be placed on the form, but additional time was added to account for 
supervisory review. The Commission believes broker-dealers would 
have an attorney perform this task. According to the SIA Management 
and Professional Earnings 2000 report, Tables 107 (Attorney) and 108 
(Compliance Attorney), the hourly cost of an attorney + 35% overhead 
is $156.00 per hour. ($156.00  x  2) = approximately $312.00 per 
broker-dealer.
    \138\ The Commission estimated in its Reproposal that, on 
average, this requirement will obligate a broker-dealer to spend 
approximately 30 minutes each year to ensure that the records are in 
compliance with these amendments. The Commission received no 
specific comments relating to this estimate. The Commission believes 
firms may have senior compliance personnel perform this task. 
According to the SIA Management and Professional Earnings 2000 
report, Table 051, the hourly cost of a Compliance Manager + 35% 
overhead is $101.25. ($101.25  x  \1/2\ hour) = approximately $50.63 
per broker-dealer.
    \139\ The Commission estimated in its Reproposal that it will 
take each firm 10 additional minutes each year to assure compliance 
with the amendments, and it received no specific comments relating 
to this estimate. The Commission believes that firms will have 
senior compliance personnel perform this task. According to the SIA 
Management and Professional Earnings 2000 report, Table 051, the 
hourly cost of a Compliance Manager + 35% overhead is $101.25. 
($101.25  x  10 minutes/60 minutes in an hour) = approximately 
$16.88 per broker-dealer.
---------------------------------------------------------------------------

IX. Effects on Efficiency, Competition, and Capital Formation

    Section 23(a)(2) of the Exchange Act \140\ requires the Commission, 
in adopting Exchange Act rules, to consider the impact any such rule 
would have on competition and to not adopt a rule that would impose a 
burden on competition not necessary or appropriate in furthering the 
purposes of the Exchange Act. Section 3(f) of the Exchange Act \141\ 
provides that whenever the Commission is engaged in rulemaking and is 
required to consider or determine whether an action is necessary or 
appropriate in the public interest, the Commission shall consider, in 
addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation. The Commission 
has considered the amendments to Rules 17a-3 and 17a-4 in light of the 
standards in Sections 23(a)(2) and 3(f) of the Exchange Act.
---------------------------------------------------------------------------

    \140\ 15 U.S.C. 78w(a)(2).
    \141\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    In the Reproposing Release, the Commission requested comment on the 
effect of the reproposed rule amendments on competition, efficiency, 
and capital formation.\142\ The Commission received 115 substantive 
comment letters\143\ in response to the Reproposal. Approximately 44% 
were from broker-dealers opposing particular amendments and 
approximately 37% were from State Securities Regulators supporting the 
amendments. Few commenters provided any information on how these 
amendments would affect competition, efficiency, or capital formation. 
One commenter argued that, ``[c]ompetition among broker-dealers is 
facilitated by the amendments to the [Books and Records Rules]'' 
because they ``[allow] firms to create and maintain records by 
alternative means * * *.'' \144\ Conversely, a few of commenters argued 
that; (i) the requirement to maintain records at local offices would 
place an unfair competitive burden upon smaller broker-dealers who do 
not have the resources to utilize imaging technology,\145\ and (ii) the 
amendments would have a disparate impact on non-traditionally organized 
broker-dealers with limited businesses.\146\ In addition, a number of 
commenters, while not specifically addressing this issue, did argue 
that it would be duplicative to maintain records at a local office 
while also maintaining the same documents at a main office. In response 
to these concerns and others, the Commission has modified the 
amendments to allow firms the flexibility to promptly produce records 
at the offices to which they relate instead of maintaining those 
records at the offices,\147\ and has added exemptions in recognition of 
present business practices.\148\
---------------------------------------------------------------------------

    \142\ Supra note 9, at 54411.
    \143\ Of the 144 total ``comment letters'' on file, seventeen 
are memos by the staff of the Commission relating to meetings with 
various industry groups, and twelve simply request that the comment 
period be extended.
    \144\ See, Comment Letter from NASAA, p. 7.
    \145\ See, Comment Letters from Titan Value Equities Groups, 
Inc., p. 3; BenefitsCorp Equities, Inc., p. 2; and One Orchard 
Equities, Inc. p. 2.
    \146\ See, Comment Letter from MML Investor Services, Inc., pp. 
5 to 6.
    \147\ Paragraph (k) of Rule 17a-4.
    \148\ See paragraphs (a)(6)(ii) and (a)(17)(i)(D) of Rule 17a-3. 
In addition, paragraph (a)(17) of Rule 17a-3 was modified to limit 
the requirement to accounts with a natural person as the customer.
---------------------------------------------------------------------------

    The Commission believes that any burden imposed by the amendments 
is justified by the enhanced investor protections described above. 
Further, as NASAA pointed out in its comment letter, when addressing 
Section 23(a) concerns, ``the [amendments] to Rules 17a-3 and 17a-4, 
pursuant to a directive by Congress, must also reflect the needs of the 
State Securities Regulators as well as federal regulators.''\149\ In 
addition, by improving examination capabilities of all securities 
regulatory authorities, the amendments should improve investor 
confidence in broker-dealer firms and help to maintain fair and orderly 
markets.
---------------------------------------------------------------------------

    \149\ See Comment Letter from NASAA, p. 4.
---------------------------------------------------------------------------

    Broker-dealers with larger customer bases would have 
correspondingly greater obligations under the amendments than smaller 
broker-dealers. Accordingly, any burden on competition should be 
slight, especially in light of the significant regulatory benefits 
discussed above.

X. Summary of Final Regulatory Flexibility Analysis

    A Final Regulatory Flexibility Analysis (``FRFA'') regarding the 
amendments to Rules 17a-3 and 17a-4 under the Exchange Act,\150\ which 
require broker-dealers to maintain certain additional records, specify 
that certain books and records must be maintained at each office, and 
set forth the length of time these records must be kept, has been 
prepared in accordance with the provisions of the Regulatory 
Flexibility Act (5 U.S.C. 604).
---------------------------------------------------------------------------

    \150\ 15 U.S.C. 78a et. seq., adopted on October 11, 1996.
---------------------------------------------------------------------------

A. Need for the Rules and Rule Amendments

    As discussed more fully in the FRFA, these amendments are intended 
to provide the Commission, SROs, and State Securities Regulators with 
timely access to broker-dealers' books and records to conduct effective 
examinations, investigations and enforcement actions. NSMIA prohibits 
States from establishing books and records rules that differ from, or 
are in addition to, the Commission's rules, and provides that the 
Commission must consult periodically with the States concerning the 
adequacy of the Commission's books and records rules,\151\ particularly 
with regard to whether the Commission's rules satisfy State Securities 
Regulators' need to have

[[Page 55833]]

records readily accessible for their examinations.\152\
---------------------------------------------------------------------------

    \151\ 15 U.S.C. 78o(h).
    \152\ See supra note 8.
---------------------------------------------------------------------------

    If these amendments are not adopted, the Commission believes that 
the Commission staff and State Securities Regulators will be hampered 
in their efforts to obtain documentation, because the books and records 
that broker-dealers maintain may not always be sufficient or in such 
order as to enable regulators to conduct thorough and effective 
examinations, investigations, and enforcement proceedings. The 
Commission further believes that a failure to re-establish certain 
customer protection safeguards present in the marketplace prior to the 
enactment of NSMIA would reduce the regulatory oversight of broker-
dealers. In addition, the Commission believes that this may also reduce 
customer confidence in the marketplace, which would be detrimental to 
market integrity and capital formation.

B. Small Entities Subject to the Rule

    It is expected that these amendments will affect the approximately 
1,000 broker-dealers that fall within the category of ``small 
business'' \153\ (``Small Business Broker-Dealers''). The amendments 
would affect these Small Business' Broker-Dealers because they, like 
other broker-dealers, would have to create and maintain certain 
additional books and records and would have to provide access to 
specific books and records at each office. An OTC Derivatives Dealer 
would not be considered a small entity because of the minimum net 
capital requirement.
---------------------------------------------------------------------------

    \153\ Pursuant to 17 CFR 240.0-10, the term ``small business'' 
or ``small organization'' when used with reference to a broker or 
dealer means a broker or dealer that: (i) had total capital (net 
worth plus subordinated liabilities) of less than $500,000 on the 
date its audited financial statements for the prior fiscal year were 
prepared pursuant to 17 CFR 240.17-5(d) or, if not required to file 
such statements, a broker-dealer that had total net capital (net 
worth plus subordinated liabilities) of less than $500,000 on the 
last business day of the preceding fiscal year (or in the time that 
it has been in business, if shorter); and (ii) is not affiliated 
with any person (other than a natural person) that is not a small 
business or small organization as defined in 17 CFR 240.0-10. In 
addition, Exchange Act Release No. 40122 (June 24, 1998) 63 FR 35508 
(June 30, 1998) recently amended standard that defines what it means 
to be ``affiliated'' with any person that is not a small business.
---------------------------------------------------------------------------

    A summary of the Initial Regulatory Flexibility Analysis (``IRFA'') 
appeared in the Reproposing Release,\154\ where the Commission 
specifically requested comment with respect to the IRFA. In response to 
the Reproposing Release, the Commission received only one comment 
letter specifically concerning the IRFA.\155\ In addition, three other 
commenters addressed aspects of the reproposed rules and rule 
amendments that could potentially affect small businesses.\156\
---------------------------------------------------------------------------

    \154\ See supra note 9.
    \155\ See Comment Letter from American Council of Life 
Insurance, p. 16.
    \156\ See Comment Letters from Titan Value Equities Group, Inc., 
pp. 2-3; Lawrence Lowman, p. 1; and John Hancock Distributors, Inc., 
p. 3.
---------------------------------------------------------------------------

    The commenter that did specifically discuss the IRFA stated, ``The 
Initial Regulatory Flexibility Analysis does not give careful 
consideration to the economic impact on [broker-dealers that limit 
their business in certain ways\157\] of the new account cards, blotter 
records, and signatures of principals on account cards.'' However, the 
Commission has carefully considered the economic impact of these rules 
on various types of broker-dealers. Furthermore, the Commission notes 
that the commenter does not take into account the fact that, even with 
respect to broker-dealers that limit their business, existing NASD 
rules\158\ require that broker-dealers maintain certain customer 
account information, including the signature of a principal accepting 
the account, and that Rule 17a-3(a)(1) \159\ presently requires that 
broker-dealers retain blotter records. The Commission has amended new 
paragraph 17a-3(a)(17) to provide an exemption from obtaining certain 
information where broker-dealers have no Federal or SRO suitability 
requirement and are therefore not otherwise required to obtain that 
information.
---------------------------------------------------------------------------

    \157\ E.g., broker-dealers which only facilitate transactions in 
certain types of products or broker-dealers which do not make 
recommendations.
    \158\ See e.g., NASD Rule 3110(c).
    \159\ 17 CFR 240.17a-4(a)(1).
---------------------------------------------------------------------------

    Of the three commenters that addressed aspects of the reproposed 
rules and rule amendments that could potentially affect small 
businesses, one stated, ``[t]he proposal to require blotters in local 
offices may cause an initial financial burden to firms which have * * * 
three or less broker offices.'' \160\ Another argued that the 
requirement to maintain records at local offices ``place[s] an unfair 
competitive burden on smaller broker-dealers who do not have the 
resources to image the required documents and place them upon a network 
that is available to both the firm's principal office and the local 
branch.'' \161\ While the amendments as reproposed would require that 
firms maintain certain records in each local office or produce those 
records within the same business day that they are requested, the 
amendments have been changed in order to give firms the flexibility to 
produce those records promptly when they are requested by a 
representative of a securities regulatory authority. This change 
significantly reduces the cost of the amendments for most firms. In 
addition, recognizing that broker-dealers may not be required to 
maintain those records under SRO rules or other regulations, the 
Commission has attempted to reduce the impact of these amendments on 
firms that engage in certain specialized types of businesses by 
changing the amendments to allow those broker-dealers to utilize 
records they presently create and maintain in compliance with SRO or 
other rules and prudent business practices.
---------------------------------------------------------------------------

    \160\ See Comment Letter from Lawrence Lowman, p. 1.
    \161\ See Comment Letter from Titan Value Equities, p. 3.
---------------------------------------------------------------------------

    Another firm contended that the requirement to update account 
records is unduly burdensome on smaller firms because such firms lack 
the automation to perform that task quickly and without additional 
personnel.\162\ The Commission has attempted to make these amendments 
sufficiently flexible to accommodate different types of operational 
systems, and broker-dealers may choose the operational methods that 
best suit their business in order to comply with the amendments.
---------------------------------------------------------------------------

    \162\ Id., p. 2.
---------------------------------------------------------------------------

    Lastly, another firm disagreed with the Commission's statement in 
the Reproposing Release that, ``[l]arger broker-dealers would have 
correspondingly greater obligations under the amendments,'' \163\ 
stating, ``the `wire house' firms will be virtually unaffected by this 
proposal,'' because ``wire houses * * * have very few small offices.'' 
\164\ To the extent that Small Business Broker-Dealers service fewer 
customer accounts, employ fewer associated persons, and operate fewer 
offices than larger broker-dealers, they will be affected by the rule 
in proportion to their size.
---------------------------------------------------------------------------

    \163\ See Comment Letter from John Hancock Distributors, Inc., 
p. 3.
    \164\ Id.
---------------------------------------------------------------------------

C. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    Most broker-dealers, including Small Business Broker-Dealers, 
already maintain many of the records specified in the amendments in the 
ordinary course of business. The Commission's intent has been to 
minimize the impact of the amendments on all broker-dealers by 
limiting, consistent with the objectives of the amendments, the number 
of instances in which broker-dealers would be obligated to create or

[[Page 55834]]

maintain records that they do not already maintain in the ordinary 
course of business. In addition, the amendments were designed to be 
sufficiently flexible to accommodate different types of recordkeeping 
systems, and broker-dealers may choose the format in which they wish to 
maintain those records.

D. Agency Action To Minimize Effect on Small Entities

    As discussed further in the FRFA, the Commission has attempted to 
minimize the economic impact these amendments might have on broker-
dealers, including Small Business Broker-Dealers, while still achieving 
the overall objective of assuring that regulators have the ability to 
perform effective examinations, including examinations for sales 
practice issues. In response to comments elicited by the Reproposing 
Release, many significant changes were made to the amendments to reduce 
the burdens associated with these amendments.
    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objective, 
while minimizing any significant adverse impact on small entities. The 
Commission considered the following alternatives: (i) The establishment 
of differing compliance or reporting requirements or timetables that 
take into account the resources available to small entities; (ii) the 
clarification, consolidation, or simplification of compliance and 
reporting requirements under the rules for small entities; (iii) the 
use of performance rather than design standards; and (iv) an exemption 
from coverage of the rule, or any part thereof, for small entities. The 
Commission also considered whether these alternatives to the reproposed 
rules and rule amendments would accomplish the stated objectives of 
improving the effectiveness of the Commission's and State regulatory 
agencies' ability to perform investigations, examinations and 
enforcement actions.
    The additional burdens placed on Small Business Broker-Dealers will 
vary depending upon the number of customer accounts at the firm, the 
number of associated persons employed by the firm, and the number of 
offices that the firm operates. Further, the rule provides substantial 
flexibility in the manner in which firms may comply with the 
amendments. Additionally, the Commission believes that obtaining 
essential information regarding the sales practices of all broker-
dealers, including Small Business Broker-Dealers, is necessary to 
permit securities regulators to effectively oversee the securities 
markets and protect investors; therefore, the Commission does not 
believe that establishing differing compliance or reporting 
requirements for Small Business Broker-Dealers would be appropriate.
    The Commission believes that the proposal could not be formulated 
differently for Small Business Broker-Dealers and still achieve the 
stated objectives. The Commission has considered Small Business Broker-
Dealers in developing the amendments and has determined that all types 
of broker-dealers, including Small Business Broker-Dealers, engage in 
sales practice abuses; therefore, the Commission does not believe that 
further clarification, consolidation, or simplification of the proposed 
amendments would be appropriate. As stated previously, however, the 
Commission has made every effort to assure that, to the extent 
possible, the amendments require broker-dealers to maintain the same 
types of records required under other federal and SRO rules or that 
firms usually maintain as part of their present business practices, and 
has highlighted instances where records that broker-dealers presently 
maintain may serve to fulfill the requirements under these amendments.
    The Commission does not believe that it would be appropriate to use 
performance standards, rather than design standards, with relation to 
these amendments. Because information must be collected and maintained 
in a uniform manner to be useful, design standards are necessary to 
achieve the objectives of the proposal. Any additional burden placed on 
broker-dealers by these amendments is dependent on the number of 
accounts serviced, the number of associated persons employed, and the 
number of offices operated. Thus, although the use of performance 
standards would be an inappropriate measure with relation to these 
amendments, the standards used do take into account the size of each 
firm. The Commission also notes that the recordkeeping requirements 
permit broker-dealers to keep records in different formats or systems 
as long as specified information can be sorted and produced upon 
request.
    Lastly, customers may be exposed to fraud and sales practice 
violations by Small Business Broker-Dealers as well as other firms. 
Exempting Small Business Broker-Dealers from coverage of the rules, or 
any part thereof, would create a gap in industry oversight, where 
regulatory authorities may be unable to obtain documentation necessary 
to conduct comprehensive examinations of Small Business Broker-Dealers. 
Therefore, the Commission believes that it should not exempt Small 
Business Broker-Dealers from the requirements of the amendments.
    The Commission believes that enacting the amendments in their 
present form is the best way to assure that regulators have the ability 
to perform effective examinations, including examinations for sales 
practice issues, and that no less burdensome alternatives are available 
to accomplish the objectives of the amendments. As stated previously, 
after NSMIA, States were constrained from ``establishing books and 
records rules that differ from, or are in addition to the Commission's 
rules.'' \165\ The States play an integral role in achieving customer 
protection by performing examinations on broker-dealers within their 
jurisdiction and reviewing for sales practice violations. Without these 
amendments, the States may be unable to obtain those books and records 
necessary to conduct comprehensive examinations. Finally, the 
Commission believes that most Small Business Broker-Dealers currently 
maintain certain of the additional records specified in the amendments.
---------------------------------------------------------------------------

    \165\ 15 U.S.C. 78o(h).
---------------------------------------------------------------------------

    A copy of the FRFA may be obtained by contacting Bonnie L. Gauch, 
Attorney, United States Securities and Exchange Commission, 450 Fifth 
Street, NW, Washington, DC 20549-1001.

XI. Paperwork Reduction Act

    Certain provisions of the amendments contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995.\166\ The Commission has submitted the 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 
``Books and Records Rule Amendments.'' The rules being amended contain 
currently approved collections of information under OMB control numbers 
3235-0033 and 3235-0279 respectively. The collections and maintenance 
of information, and the reports made to the SEC and others that are 
required pursuant to Rules 17a-3 and 17a-4 are mandatory. An agency may 
not conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a currently valid control 
number.
---------------------------------------------------------------------------

    \166\ 44 U.S.C. 3502 et seq.

---------------------------------------------------------------------------

[[Page 55835]]

A. Collection of Information Under the Amendments

    As discussed previously in this release, the Books and Records Rule 
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 Books and Records Rule 
Amendments would be used by the Commission, SROs, and other securities 
regulatory authorities for examinations, investigations, 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 as required to facilitate 
examinations, investigations, and enforcement proceedings. To comply 
with the amendments that require broker-dealers to update customer 
account records at least once every 36 months, broker-dealers would 
have to furnish the customers with copies of their account records. 
This requirement and the estimated burden associated with it are 
discussed in detail below.

C. Respondents

    The Books and Records Rule Amendments would apply to all of the 
approximately 7,217 active broker-dealers that are registered with the 
Commission.\167\
---------------------------------------------------------------------------

    \167\ Of approximately 7,739 broker-dealers registered with the 
Commission, approximately 341 are not yet active because their 
registration is pending SRO approval and approximately 181 are 
inactive because they have ceased doing a securities business and 
have filed a Form BDW with the Commission. Of these 7,217 active, 
registered broker-dealers, three are registered OTC Derivatives 
Dealers. OTC Derivatives Dealers are a special class of broker-
dealers that limit their business to dealer activities in eligible 
over-the-counter derivative instruments and that meet certain 
financial responsibility and other requirements.
---------------------------------------------------------------------------

D. Total Annual Reporting and Recordkeeping Burden

    The hour burden of the Books and Records Rule Amendments is 
difficult to ascertain, because any additional burdens would vary 
widely due to differences in broker-dealer activity levels and current 
recordkeeping systems employed by the broker-dealers. Therefore, the 
estimates in this section are based on averages among the various types 
and sizes of broker-dealers. Recognizing that large broker-dealers 
maintaining over 100,000 customer accounts are generally more automated 
than small broker-dealers maintaining less than 100,000 customer 
accounts with relation to certain of the amendments, the Commission has 
attempted to provide for these differences in its calculations.
    Most of the requirements of the Books and Records Rule Amendments 
involve collections of information that broker-dealers already maintain 
pursuant to prudent business practices or to comply with existing SRO 
regulations. While some of the comment letters argued that the 
Commission's estimates set forth in the Reproposing Release were low, 
few contained actual alternative cost estimates, and none contained 
estimates which could be applied generally to broker-dealer firms. The 
Commission has increased its estimation of the expected burden of the 
amendments where, in general, commenters felt that the estimates were 
too low, and has provided a more detailed explanation of its estimates 
where it believes the amendments will impose little or no additional 
burden on broker-dealers. In addition, in response to the comments 
received relating to the Reproposing Release, the Commission modified 
its proposal and adopted amendments that reduce the amount of 
additional records that firms will be required to create and maintain.
1. Rule 17a-3
    The amendments modify Rule 17a-3 by, among other things, requiring 
broker-dealers to send account information to customers for 
verification within 30 days of account opening and at least once every 
36 months thereafter. As stated above, the total number of accounts 
that would need to be contacted for updating is 70,500,000.\168\ 
Approximately 70 of the 7,217 active, registered broker-dealers 
maintain over 100,000 accounts, and the remaining broker-dealers 
(7,147) maintain less than 100,000 accounts each. Of the 70,500,000 
accounts which may be affected by these amendments, approximately 
68,385,000 (or 97%) are maintained at these large broker-dealers, and 
2,115,000 (or 3%) are maintained at broker-dealers with less than 
100,000 accounts each.
---------------------------------------------------------------------------

    \168\ Supra note 117.
---------------------------------------------------------------------------

    The Commission estimates that, as their processes are more 
automated, it will take large broker-dealers an average of 1\1/2\ 
additional minutes per account every three years,\169\ thus requiring 
large broker-dealers to spend an additional 569,875 hours per year 
(68,385,000 account records/3 years  x  1.5 minutes / 60 minutes) to 
send account information to customers. As small broker-dealers utilize 
processes which are more manual in nature,\170\ the Commission 
estimates that it will take small broker-dealers an average of 7 
minutes per account \171\ every three years, thus requiring small 
broker-dealers to spend an additional 82,250 hours per year (2,115,000 
account records/3 years  x  7 minutes/60 minutes) to send account 
records to customers. Thus the total additional burden on the industry 
to send account records to customers is 652,125 hours.
---------------------------------------------------------------------------

    \169\ The Commission, in its Reproposal, estimated that it would 
take broker-dealers 10 seconds to furnish the account record to 
customers. Because many commenters contended that this estimate was 
too low, the Commission raised its estimates.
    \170\ Supra note 121.
    \171\ See Comment Letter from Comerica Securities, p. 2.
---------------------------------------------------------------------------

    The Commission estimates that approximately 20% \172\ of the 
customers from whom information is requested will update their account 
record resulting in 4,700,000 updated account records each year 
(70,500,000/3 years  x  20%). The Commission estimates that it would 
take, on average, 5 minutes for large broker-dealers to update each 
account and 10 minutes \173\ for small broker-dealers to update each 
account, resulting in an additional burden of 403,417 hours per year 
((4,559,000 account records  x  5 minutes/60 minutes) + (141,000 
account records  x  10 minutes/60 minutes)). 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. While it is acknowledged 
that some customers will provide broker-dealers with changes to their 
account information outside of this update process, as those are 
changes broker-dealers must contend with in the present environment, 
the amendments create no additional burden in this regard. Broker-
dealers presently maintain current account records in the ordinary 
course of their business because existing SRO rules require them to 
maintain current information about their customers.
---------------------------------------------------------------------------

    \172\ See Comment Letter from Merrill Lynch, p. 7.
    \173\ See Comment Letter from Titan Value Equities, Inc., p. 2.
---------------------------------------------------------------------------

    If a customer has provided the broker-dealer with updated account 
record information, under paragraphs (a)(17)(i)(B) (2) and (3) of Rule 
17a-3 the broker-dealer must send a copy of the revised account record 
to the customer within 30 days after it received notification of the 
change or, under paragraph (a)(17)(i)(B)(3), the broker-

[[Page 55836]]

dealer may send the notification with the next statement mailed to the 
customer. The Commission estimates that, in addition to the 70,500,000 
updated account records discussed above, 3,525,000 customers (5% of the 
70,500,000 accounts for which firms will be required to make the 
account record) will initiate changes to their account records on a 
yearly basis, just as they do now, with no prompting from any account 
record mailing. The Commission estimates, as stated above, that it will 
take large broker-dealers 1\1/2\ minutes and smaller broker-dealers 7 
minutes to send out account information to each customer who updated 
their account. The Commission estimates that 8,225,000 (4,700,000 + 
3,525,000) customers will update their account record, and that broker-
dealers will spend an additional 228,244 hours each year ((7,978,250 
account records x 1.5 minutes / 60 minutes) + (246,750 account records 
x 7 minutes / 60 minutes)) sending the updated account records to 
customers.
    The amendments also impose a requirement that broker-dealers obtain 
the following additional information for each account with a natural 
person as the customer: the customer name, tax identification number, 
address, telephone number, date of birth, employment status, annual 
income, net worth, investment objectives, and the signature of the 
associated person and a principal. Present Rule 17a-3(a)(9) already 
requires that a firm maintain a record of a customer's name and 
address. Further, SRO rules require that firms obtain and maintain 
records of: whether a customer is of legal age (firms usually obtain a 
customer's date of birth to satisfy this requirement), the signature of 
the registered representative and principal, a customer's tax 
identification number, the customer's occupation, and whether or not 
the customer is associated with another broker-dealer.\174\ In 
addition, certain SRO rules require that before making any 
recommendations to customers, broker-dealers obtain information, 
regarding the customer's annual income, net worth, and the investment 
objectives for the account in question in order to formulate a basis 
for any recommendation.\175\
---------------------------------------------------------------------------

    \174\ See NASD Rules 3110(c) and IM-2860-2, and NYSE Rules 405, 
407, 410A, and 721.10.
    \175\ See e.g., NASD Rule 2310(b) and IM-2860-2.
---------------------------------------------------------------------------

    In addition, the amendments require that, if the account is a 
discretionary account, the firm must obtain (i) The signature of the 
customer granting discretion, (ii) the date discretion was granted, and 
(iii) the signature of the person to whom discretion was granted. 
Certain SRO rules require that for discretionary accounts, broker-
dealers must obtain the signature of the person who was granted 
discretion, and the date discretion was granted,\176\ while other SRO 
rules require that firms obtain written authorization of the customer 
before exercising discretion in an account.\177\ Further, the 
Commission believes that obtaining these records is a prudent business 
practice followed by most broker-dealers to avoid disputes with 
customers.
---------------------------------------------------------------------------

    \176\ Supra note 158.
    \177\ See e.g., NYSE Rule 408.
---------------------------------------------------------------------------

    In addition to the account record requirements, the amendments 
require broker-dealers to keep certain records regarding their 
associated persons, including all agreements pertaining to the 
associated persons relationship with the broker-dealer and a summary of 
each associated person's compensation arrangement,\178\ a record 
delineating all identification numbers relating to each associated 
person,\179\ a record of the office at which each associated person 
regularly conducts business,\180\ and a record as to each associated 
person listing transactions for which that person will be 
compensated.\181\ The Commission believes that broker-dealers generally 
create and maintain these records under prudent recordkeeping 
procedures. Therefore, the Commission estimates that, on average, these 
records would require each broker-dealer to spend approximately 30 
minutes each year to ensure that it is in compliance with these 
amendments, a total of about 3,609 hours ((7,217 broker-dealers x 30 
minutes/60 minutes).
---------------------------------------------------------------------------

    \178\ Supra note 126.
    \179\ Supra note 127.
    \180\ Supra note 128.
    \181\ Supra note 129.
---------------------------------------------------------------------------

    The amendments also require broker-dealers to keep a record 
relating to written customer complaints that includes: 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. In order to account for differing broker-
dealer practices, the Commission has provided broker-dealers with an 
alternative; instead of creating what may be a new record, broker-
dealers can simply maintain a copy of each complaint, along with a 
record of the disposition of the complaint.\182\ Firms are presently 
required to maintain copies of all communications under Rule 17a-
4(b)(4), and certain SRO rules require that members maintain copies of 
all written complaints and a record of the actions taken by the broker-
dealer in specified offices, and that copies of options-related 
complaints be maintained in both the main office and in the branch 
office to which they relate.\183\ Most firms maintain copies of all 
complaints and related information and documents at their headquarters, 
and some already maintain both option and non-option complaints at all 
offices as well. While the Reproposal would have required that 
complaints relating to an office be maintained in that office or be 
produced on the business day they are requested, the amendments as 
adopted require only that records of complaints for an office be 
produced promptly at the office to which the complaints relate.
---------------------------------------------------------------------------

    \182\ 17 CFR 240.17a-3(a)(18)(i).
    \183\ Supra note 136.
---------------------------------------------------------------------------

    The amendments also require broker-dealers to make records which 
indicate that they have complied with applicable regulations of certain 
securities regulatory authorities,\184\ which list persons who can 
explain the information in the broker-dealer's records,\185\ and that 
list principals responsible for establishing compliance policies and 
procedures.\186\ Firms presently maintain records to evidence 
compliance with SRO and other rules; therefore, no additional burden is 
created by this amendment. The Commission believes that broker-dealers 
presently maintain lists of principals or branch managers responsible 
for supervising each of their offices under applicable SRO rules, and 
that they also have lists of associated persons operating out of each 
office location. Under certain SRO rules, broker-dealers must presently 
have supervisory systems in place that include identification of 
principals responsible for reviewing the firm's procedures and taking 
action to achieve compliance with applicable securities laws, 
regulations and rules.\187\ The Commission estimates, therefore, that 
on average each broker-dealer would spend 10 minutes each year to 
ensure compliance with these requirements, yielding a total additional 
burden of about 1,203 hours ((7,217 broker-dealers x 10 minutes/60 
minutes).
---------------------------------------------------------------------------

    \184\ 17 CFR 240.17a-3(a)(17)(ii) and 17 CFR 240.17a-3(a)(20).
    \185\ Supra note 133.
    \186\ Supra note 134.
    \187\ Supra note 135.
---------------------------------------------------------------------------

    The amendments relating to order tickets require that broker-
dealers note, in addition to information already required, the identity 
of the associated

[[Page 55837]]

person responsible for an account and the identity of the person who 
accepted the order, and whether the order was entered pursuant to 
discretionary authority. In addition, the amendments to Rule 17a-
3(a)(6) require that firms record the time an order was received from a 
customer, and the amendments to Rule 17a-3(a)(7) require that firms 
make a record of any modifications to an order. SRO rules already 
require that firms record, maintain, and in some cases report, the time 
an order was received, and information regarding modification and 
cancellation including instructions and the time.\188\ Further, firms 
who assign associated persons to particular accounts usually refer the 
customer to that person to initiate transactions. The identity of the 
person who accepted the order from the customer, whether or not it was 
the person assigned to the account, is generally recorded and 
maintained at the present time by firms as a prudent business practice 
that assists the firm in properly supervising the activities of their 
associated persons and assuring that commissions are properly paid. In 
addition, the amendment to Rule 17a-3(a)(6) contains an exception for 
transactions done on a ``subscription-way'' basis, where an application 
or subscription agreement is sent to the issuer in place of an order 
ticket. For these types of transactions, broker-dealers may keep the 
application or subscription agreement in the place of the order ticket. 
Thus the Commission does not believe that the amendments to Rules 17a-
3(a)(6) and 17a-3(a)(7) will cause any additional burden.
---------------------------------------------------------------------------

    \188\ Supra note 102.
---------------------------------------------------------------------------

    In total, the Commission estimates that compliance with the 
amendments to Rule 17a-3 will require an additional 1,288,598 hours 
(1,283,786 \189\ + 3,609 \190\ + 1,203 \191\).
---------------------------------------------------------------------------

    \189\ 17 CFR 240.17a-3(a)(17).
    \190\ 17 CFR 240.17a-3(12) and (19).
    \191\ 17 CFR 240.17a-3(a)(20) to (22).
---------------------------------------------------------------------------

2. Rule 17a-4
    The amendments modify Rule 17a-4 by requiring broker-dealers to 
maintain certain additional books and records, including a record 
listing all persons who are qualified to explain a broker-dealer's 
books and records. The amendments also require broker-dealers to make 
available certain records at each office. As discussed above, new Rule 
17a-4(k) was modified to provide that, instead of requiring that firms 
either maintain copies of records in the office to which they pertain, 
broker-dealers now have the option of producing certain records which 
relate to a particular office ``promptly.'' This significantly reduces 
the additional burden caused by the amendments to Rule 17a-4.
    The amendments also increase the amount of time broker-dealers must 
maintain certain records. Broker-dealers generally maintain these 
records to comply with other federal or SRO Rules or in the normal 
course of business. These records include, (i) information relating to 
the principals responsible for reviewing and updating policies and 
procedures, (ii) copies of Forms BD, BDW and amendments thereto, (iii) 
copies of compliance, supervisory, and procedures manuals, (iv) 
customer account records, (v) order ticket information, (vi) records 
relating to compensation of associated persons, (vii) evidence of 
compliance with SRO advertising and sales literature rules, (viii) 
exception reports, and (ix) specialized reports produced pursuant to an 
order or settlement.
    Based upon the information above, and due to the fact that the 
amendments to Rule 17a-4 require only that information be kept for 
prescribed periods of time, the Commission estimates that, on average, 
each broker-dealer would spend four hours each year to ensure that it 
is in compliance with the amendments to Rule 17a-4 and to produce 
required records promptly at an office when so required. Therefore, the 
Commission estimates that compliance with the amendments for Rule 17a-4 
would require an additional 28,868 hours each year ((7,217 broker-
dealers x 4 hours).

E. Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to--(i) Evaluate whether the proposed collections of 
information are necessary for the proper performance of the functions 
of the agency, including whether the information shall have practical 
utility; (ii) Evaluate the accuracy of the agency's estimate of the 
burden of the proposed collections of information; (iii) Enhance the 
quality, utility, and clarity of the information to be collected; (iv) 
Minimize the burden of the collections of information on those who are 
to respond, including through the use of automated collection 
techniques or other forms of information technology. The Commission 
encourages commenters to identify and supply any relevant data, 
analysis and estimates concerning the burden of the proposed rules, 
especially where any commenter believes the Commission's estimates to 
be inaccurate.
    Persons desiring to submit comments on the collection of 
information requirements proposed above should direct them to the 
following persons: (1) Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Office of 
Management and Budget, Room 10102, New Executive Office Building, 
Washington, DC 20503; and (2) Jonathan G. Katz, Secretary, Securities 
and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-
0609 with reference 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, so a comment to OMB is best assured of having 
its full effect if OMB receives it within 30 days of publication. The 
Commission has submitted the proposed collections of information to OMB 
for approval. Requests for the materials submitted to OMB by the 
Commission with regard to these collections of information should be in 
writing, refer to File No. S7-26-98, and be submitted to the Securities 
and Exchange Commission, Records Management, Office of Filings and 
Information Services, 450 Fifth Street, NW., Washington, DC 20549.

XII. Statutory Basis

    The amendments are adopted 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 Parts 240 and 242

    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 amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for Part 240 is amended by adding the 
following citation:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4 and 80b-11, unless otherwise noted.

* * * * *
    Section 240.17a-4 also issued under secs. 2, 17, 23(a), 48 Stat. 
897, as amended; 15 U.S.C. 78a, 78d-1, 78d-2; sec. 14, Pub. L. 94-
29, 89 Stat. 137 (15 U.S.C. 78a); sec. 18, Pub. L. 94-29, 89 Stat. 
155 (15 U.S.C. 78w);
* * * * *


[[Page 55838]]



    2. The authority citations following Secs. 240.17a-3 and 240.17a-4 
are removed.

    3. Section 240.17a-3 is amended by:
    a. Revising paragraphs (a)(6) and (a)(7);
    b. Revising the introductory text of paragraph (a)(12)(i);
    c. Revising paragraph (a)(12)(ii);
    d. Redesignating paragraphs (a)(12)(i)(a) through (a)(12)(i)(h) as 
paragraphs (a)(12)(i)(A) through (a)(12)(i)(H); and
    e. Adding paragraphs (a)(17), (a)(18), (a)(19), (a)(20), (a)(21), 
(a)(22), (f) and (g).
    The revisions and additions read as follows:


Sec. 240.17a-3  Records to be made by certain exchange members, brokers 
and dealers.

    (a) * * *
    (6)(i) 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 
identity of each associated person, if any, responsible for the 
account; the identity of any other person who entered or accepted the 
order on behalf of the customer or, if a customer entered the order on 
an electronic system, a notation of that entry; and, to the extent 
feasible, the time of execution or cancellation. The memorandum need 
not show the identity of any person, other than the associated person 
responsible for the account, who may have entered or accepted the order 
if the order is entered into an electronic system that generates the 
memorandum and if that system is not capable of receiving an entry of 
the identity of any person other than the responsible associated 
person; in that circumstance, the member, broker or dealer shall 
produce upon request by a representative of a securities regulatory 
authority a separate record which identifies each other person. An 
order entered pursuant to the exercise of discretionary authority by 
the member, broker or dealer, or associated person 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.
* * * * *
    (ii) This memorandum need not be made as to a purchase, sale or 
redemption of a security on a subscription way basis directly from or 
to the issuer, if the member, broker or dealer maintains a copy of the 
customer's subscription agreement regarding a purchase, or a copy of 
any other document required by the issuer regarding a sale or 
redemption.
    (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 time of receipt; the terms and 
conditions of the order and of any modification thereof; the account 
for which it was entered; the identity of each associated person, if 
any, responsible for the account; the identity of any other person who 
entered or accepted the order on behalf of the customer or, if a 
customer entered the order on an electronic system, a notation of that 
entry. The memorandum need not show the identity of any person other 
than the associated person responsible for the account who may have 
entered the order if the order is entered into an electronic system 
that generates the memorandum and if that system is not capable of 
receiving an entry of the identity of any person other than the 
responsible associated person: in that circumstance, the member, broker 
or dealer shall produce upon request by a representative of a 
securities regulatory authority a separate record which identifies each 
other person. An order with a customer other than a member, broker or 
dealer entered pursuant to the exercise of discretionary authority by 
the member, broker or dealer, or associated person thereof, shall be so 
designated.
* * * * *
    (12)(i) A questionnaire or application for employment executed by 
each ``associated person'' (as defined in paragraph (g)(4) of this 
section) of the member, broker or dealer, which questionnaire or 
application shall be approved in writing by an authorized 
representative of the member, broker or dealer and shall contain at 
least the following information with respect to the associated person:
* * * * *
    (ii) A record listing every associated person of the member, broker 
or dealer which shows, for each associated person, every office of the 
member, broker or dealer where the associated person regularly conducts 
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 for the member, broker or dealer, and the Central 
Registration Depository number, if any, and every internal 
identification number or code assigned to that person by the member, 
broker or dealer.
* * * * *
    (17) For each account with a natural person as a customer or owner:
    (i)(A) An account record including the customer's or owner's name, 
tax identification number, address, telephone number, date of birth, 
employment status (including occupation and whether the customer is an 
associated person of a member, broker or dealer), annual income, net 
worth (excluding value of primary residence), and the account's 
investment objectives. In the case of a joint account, the account 
record must include personal information for each joint owner who is a 
natural person; however, financial information for the individual joint 
owners may be combined. The account record shall indicate whether it 
has been signed by the associated person responsible for the account, 
if any, and approved or accepted by a principal of the member, broker 
or dealer. For accounts in existence on the effective date of this 
section, the member, broker or dealer must obtain this information 
within three years of the effective date of the section.
    (B) A record indicating that:
    (1) The member, broker or dealer has furnished to each customer or 
owner within three years of the effective date of this section, and to 
each customer or owner who opened an account after the effective date 
of this section within thirty days of the opening of the account, and 
thereafter at intervals no greater than thirty-six months, a copy of 
the account record or an alternate document with all information 
required by paragraph (a)(17)(i)(A) of this section. The member, broker 
or dealer may elect to send this notification with the next statement 
mailed to the customer or owner after the opening of the account. The 
member, broker or dealer may choose to exclude any tax identification 
number and date of birth from the account record or alternative 
document furnished to the customer or owner. The member, broker or 
dealer shall include with the account record or alternative document 
provided to each customer or owner an explanation of any terms 
regarding investment objectives. The account record or alternate 
document

[[Page 55839]]

furnished to the customer or owner shall include or be accompanied by 
prominent statements that the customer or owner should mark any 
corrections and return the account record or alternate document to the 
member, broker or dealer, and that the customer or owner should notify 
the member, broker or dealer of any future changes to information 
contained in the account record.
    (2) For each account record updated to reflect a change in the name 
or address of the customer or owner, the member, broker or dealer 
furnished a notification of that change to the customer's old address, 
or to each joint owner, and the associated person, if any, responsible 
for that account, on or before the 30th day after the date the member, 
broker or dealer received notice of the change.
    (3) For each change in the account's investment objectives the 
member, broker or dealer has furnished to each customer or owner, and 
the associated person, if any, responsible for that account a copy of 
the updated customer account record or alternative document with all 
information required to be furnished by paragraph (a)(17)(i)(B)(1) of 
this section, on or before the 30th day after the date the member, 
broker or dealer received notice of any change, or, if the account was 
updated for some reason other than the firm receiving notice of a 
change, after the date the account record was updated. The member, 
broker or dealer may elect to send this notification with the next 
statement scheduled to be mailed to the customer or owner.
    (C) For purposes of this paragraph (a)(17), the neglect, refusal, 
or inability of a customer or owner to provide or update any account 
record information required under paragraph (a)(17)(i)(A) of this 
section shall excuse the member, broker or dealer from obtaining that 
required information.
    (D) The account record requirements in paragraph (a)(17)(i)(A) of 
this section shall only apply to accounts for which the member, broker 
or dealer is, or has within the past 36 months been, required to make a 
suitability determination under the federal securities laws or under 
the requirements of a self-regulatory organization of which it is a 
member. Additionally, the furnishing requirement in paragraph 
(a)(17)(i)(B)(1) of this section shall not be applicable to an account 
for which, within the last 36 months, the member, broker or dealer has 
not been required to make a suitability determination under the federal 
securities laws or under the requirements of a self-regulatory 
organization of which it is a member. This paragraph (a)(17)(i)(D) does 
not relieve a member, broker or dealer from any obligation arising from 
the rules of a self-regulatory organization of which it is a member 
regarding the collection of information from a customer or owner.
    (ii) If an account is a discretionary account, a record containing 
the dated signature of each customer or owner granting the authority 
and the dated signature of each natural person to whom discretionary 
authority was granted.
    (iii) A record for each account indicating that each customer or 
owner was furnished with a copy of each written agreement entered into 
on or after the effective date of this paragraph pertaining to that 
account and that, if requested by the customer or owner, the customer 
or owner was furnished with a fully executed copy of each agreement.
    (18) A record:
    (i) 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 the complainant's name, address, and 
account number; the date the complaint was received; the name of any 
other 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 each original complaint in a separate file by the associated person 
named in the complaint along with a record of the disposition of the 
complaint.
    (ii) 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 as to the account may be directed.
    (19) A record:
    (i) As to each associated person listing each purchase and sale of 
a security attributable, for compensation purposes, to that associated 
person. The record shall include the amount of compensation if monetary 
and a description of the compensation if non-monetary. In lieu of 
making this record, a member, broker or dealer may elect to produce the 
required information promptly upon request of a representative of a 
securities regulatory authority.
    (ii) Of all agreements pertaining to the relationship between each 
associated person and the member, broker or dealer including a summary 
of each associated person's compensation arrangement or plan with the 
member, broker or dealer, including commission and concession schedules 
and, to the extent that compensation is based on factors other than 
remuneration per trade, the method by which the compensation is 
determined.
    (20) A record, which need not be separate from the advertisements, 
sales literature, or communications, documenting that the member, 
broker or dealer has complied with, or adopted policies and procedures 
reasonably designed to establish compliance with, applicable federal 
requirements and rules of a self-regulatory organization of which the 
member, broker or dealer is a member which require that advertisements, 
sales literature, or any other communications with the public by a 
member, broker or dealer or its associated persons be approved by a 
principal.
    (21) A record for each office listing, by name or title, each 
person at that office who, without delay, can explain the types of 
records the firm maintains at that office and the information contained 
in those records.
    (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 federal 
requirements or rules of a self-regulatory organization of which the 
member, broker or dealer is a member that require acceptance or 
approval of a record by a principal.
* * * * *
    (f) Every member, broker or dealer shall make and keep current, as 
to each office, the books and records described in paragraphs (a)(1), 
(a)(6), (a)(7), (a)(12), (a)(17), (a)(18)(i), (a)(19), (a)(20), 
(a)(21), and (a)(22) of this section.
    (g) When used in this section:
    (1) The term office means any location where one 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.
    (2) The term principal means any individual registered with a 
registered national securities association as a principal or branch 
manager of a member, broker or dealer or any other person who has been 
delegated supervisory responsibility over associated persons by the 
member, broker or dealer.
    (3) The term securities regulatory authority means the Commission, 
any self-regulatory organization, or any securities commission (or any 
agency or office performing like functions) of the States.

[[Page 55840]]

    (4) The term associated person means an ``associated person of a 
member'' or ``associated person of a broker or dealer'' as defined in 
sections 3(a)(21) and 3(a)(18) of the Act (15 U.S.C. 78c(a)(21) and 
(a)(18)) respectively, but shall not include persons whose functions 
are solely clerical or ministerial.


Sec. 240.17a-3  [Amended]

    4. Section 240.17a-3 is amended by:
    a. Removing from the introductory text of paragraph (a) and 
paragraph (a)(5) the word ``his'' and in its place adding ``it'';
    b. Removing from paragraph (a)(11)(ii) the word ``he'' and in its 
place adding ``it'';
    c. Removing from redesignated paragraphs (a)(12)(i)(A) and 
(a)(12)(i)(B) the word ``His'' and in its place adding ``The associated 
person's'';
    d. Removing from redesignated paragraphs (a)(12)(i)(A), 
(a)(12)(i)(C), and (a)(12)(i)(H) the word ``his'' and in its place 
adding ``the associated person's'';
    e. Removing from redesignated paragraphs (a)(12)(i)(D) and 
(a)(12)(i)(F) the word ``him'' and in its place adding ``the associated 
person'';
    f. Removing from redesignated paragraphs (a)(12)(i)(D), 
(a)(12)(i)(E), (a)(12)(i)(F) and (a)(12)(i)(H) the word ``he'' and in 
its place adding ``the associated person'' and
    g. Removing from redesignated paragraph (a)(12)(i)(H) the phrase 
``or the American Stock Exchange, the Boston Stock Exchange, the 
Midwest Stock Exchange, the New York Stock Exchange, the Pacific Coast 
Stock Exchange, or the Philadelphia-Baltimore Stock Exchange'' and in 
its place adding ``the American Stock Exchange LLC, the Boston Stock 
Exchange, Inc., the Chicago Stock Exchange, Inc., the New York Stock 
Exchange, Inc., the Pacific Exchange, Inc., the Philadelphia Stock 
Exchange, Inc., the Chicago Board Options Exchange, Inc., the 
Cincinnati Stock Exchange, Inc. or the International Securities 
Exchange''.

    5. Section 240.17a-4 is amended by:
    a. Revising paragraph (a);
    b. Revising the introductory text of paragraph (b);
    c. Revising paragraphs (b)(1), (b)(4), (c) and (d);
    d. Revising the introductory text of paragraph (e);
    e. Adding paragraphs (e)(5), (e)(6), (e)(7), (e)(8);
    f. Revising paragraph (j); and
    g. Adding paragraphs (k) and (l).
    The revisions and additions 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, all records required to be made pursuant 
to paragraphs Sec. 240.17a-3(a)(1), (a)(2), (a)(3), (a)(5), (a)(21), 
(a)(22), and analogous records created pursuant to paragraph 
Sec. 240.17a-3(f).
    (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:
    (1) All records required to be made pursuant to Sec. 240.17a-
3(a)(4), (a)(6), (a)(7), (a)(8), (a)(9), (a)(10), (a)(16), (a)(18), 
(a)(19), (a)(20), and analogous records created pursuant to 
Sec. 240.17a-3(f).
* * * * *
    (4) Originals of all communications received and copies of all 
communications sent (and any approvals thereof) by the member, broker 
or dealer (including inter-office memoranda and communications) 
relating to its business as such, including all communications which 
are subject to rules of a self-regulatory organization of which the 
member, broker or dealer is a member regarding communications with the 
public. As used in this paragraph (b)(4), the term communications 
includes sales scripts.
* * * * *
    (c) Every member, broker and dealer subject to Sec. 240.17a-3 shall 
preserve for a period of not less than six years after the closing of 
any customer's account any account cards or records which relate to the 
terms and conditions with respect to the opening and maintenance of the 
account.
    (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 partnership articles or, in the case of a corporation, 
all articles of incorporation or charter, minute books and stock 
certificate books (or, in the case of any other form of legal entity, 
all records such as articles of organization or formation, and minute 
books used for a purpose similar to those records required for 
corporations or partnerships), all Forms BD (Sec. 249.501 of this 
chapter), all Forms BDW (Sec. 249.501a of this chapter), all amendments 
to these forms, all licenses or other documentation showing the 
registration of the member, broker or dealer with any securities 
regulatory authority.
    (e) Every member, broker and dealer subject to Sec. 240.17a-3 shall 
maintain and preserve in an easily accessible place:
* * * * *
    (5) All account record information required pursuant to 
Sec. 240.17a-3(a)(17) until at least six years after the earlier of the 
date the account was closed or the date on which the information was 
replaced or updated.
    (6) Each report which a securities regulatory authority has 
requested or required the member, broker or dealer to make and furnish 
to it pursuant to an order or settlement, and each securities 
regulatory authority examination report until three years after the 
date of the report.
    (7) Each compliance, supervisory, and procedures manual, including 
any updates, modifications, and revisions to the manual, describing the 
policies and practices of the member, broker or dealer with respect to 
compliance with applicable laws and rules, and supervision of the 
activities of each natural person associated with the member, broker or 
dealer until three years after the termination of the use of the 
manual.
    (8) All reports produced to review for unusual activity in customer 
accounts until eighteen months after the date the report was generated. 
In lieu of maintaining the reports, a member, broker or dealer may 
produce promptly the reports upon request by a representative of a 
securities regulatory authority. If a report was generated in a 
computer system that has been changed in the most recent eighteen month 
period in a manner such that the report cannot be reproduced using 
historical data in the same format as it was originally generated, the 
report may be produced by using the historical data in the current 
system, but must be accompanied by a record explaining each system 
change which affected the reports. If a report is generated in a 
computer system that has been changed in the most recent eighteen month 
period in a manner such that the report cannot be reproduced in any 
format using historical data, the member, broker or dealer shall 
promptly produce upon request a record of the parameters that were used 
to generate the report at the time specified by a representative of a 
securities regulatory authority, including a record of the frequency 
with which the reports were generated.
* * * * *
    (j) Every member, broker and dealer subject to this section shall 
furnish promptly to a representative of the Commission legible, true, 
complete, and current copies of those records of the member, broker or 
dealer that are

[[Page 55841]]

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 for the most recent two year period required to be made 
pursuant to Sec. 240.17a-3(f) and paragraphs (b)(4) and (e)(7) of this 
section which relate to an office shall be maintained at the office to 
which they relate. If an office is a private residence where only one 
associated person (or multiple associated persons who reside at that 
location and are members of the same immediate family) regularly 
conducts business, and it is not held out to the public as an office 
nor are funds or securities of any customer of the member, broker or 
dealer handled there, the member, broker or dealer need not maintain 
records at that office, but the records must be maintained at another 
location within the same State as the member, broker or dealer may 
select. Rather than maintain the records at each office, the member, 
broker or dealer may choose to produce the records promptly at the 
request of a representative of a securities regulatory authority at the 
office to which they relate or at another location agreed to by the 
representative.
    (l) When used in this section:
    (1) The term 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).
    (4) The term associated person shall have the meaning set forth in 
Sec. 240.17a-3(g)(4).


Sec. 240.17a-4  [Amended]

    6. Section 240.17a-4 is amended by:
    a. Removing from paragraph (b)(7) the word ``his'' and in its place 
adding ``its'; and
    b. Removing from paragraph (e)(1) the phrase ``the ``associated 
person'' has terminated his employment and any other connection with 
the member, broker or dealer.'' and in its place adding ``the 
associated person's employment and any other connection with the 
member, broker or dealer has terminated.''.
    c. Removing from paragraph (f)(3)(ii) 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''.
    d. Removing from paragraph (f)(3)(vii):
    i. 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,'';
    ii. 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''; and
    iii. From 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''.

PART 242--REGULATIONS M and ATS

    7. The authority citation for part 242 continues to read as 
follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78i(a), 78j, 
78k-1(c), 78l, 78m, 78mm, 78n, 78o(b), 78o(c), 78o(g), 78q(a), 
78q(b), 78q(h), 78w(a), 78dd-1, 80a-23, 80a-29, and 80a-37.

    8. In Sec. 242.303, paragraph (d) is amended by removing the phrase 
``representatives or designees of the Securities and Exchange 
Commission, and to promptly furnish to the Commission or its designee'' 
and in its place adding ``the staff of the Securities and Exchange 
Commission, any self-regulatory organization of which the alternative 
trading system is a member, or any State securities regulator having 
jurisdiction over the alternative trading system, and to promptly 
furnish to the Commission, self-regulatory organization of which the 
alternative trading system is a member, or any State securities 
regulator having jurisdiction over the alternative trading system.''

    Dated: October 26, 2001.
    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-27439 Filed 11-1-01; 8:45 am]
BILLING CODE 8010-01-P