Reports to be Made by Certain Brokers and Dealers

SUMMARY: The Securities and Exchange Commission (``Commission'') is

amending Rule 17a-5 under the Securities Exchange Act of 1934

(``Exchange Act'') to require broker-dealers to file with the

Commission and their designated examining authority (``DEA'') at

designated times two separate reports regarding their Year 2000

compliance. The reports will increase broker-dealer awareness that they

should be taking specific steps now to prepare for the Year 2000;

facilitate coordination with self regulatory organizations of industry-

wide testing, implementation, and contingency planning; supplement the

Commission's examination module for Year 2000 issues and identify

potential Year 2000 problems; and provide information regarding the

securities industry's preparedness for the Year 2000. The reports are

designed to be available to the public which will enable broker-dealer

counterparties and others to assess the risks of doing business with a

broker-dealer that may not be Year 2000 compliant.

EFFECTIVE DATE: August 12, 1998.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate

Director, 202/942-0131; Thomas K. McGowan, Assistant Director, 202/942-

4886; Lester Shapiro, Senior Accountant, 202/942-0757; or Christopher

M. Salter, Staff Attorney, 202/942-0148, Division of Market Regulation,

Securities and Exchange Commission, 450 Fifth Street, NW, Mail Stop 10-

1, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

At midnight on December 31, 1999, unless the proper modifications

have been made, the program logic in many of the world's computer

systems will start to produce erroneous results because, among other

things, the systems will incorrectly read the date ``01/01/00'' as

being the year 1900 or another incorrect date. In addition, systems may

fail to detect that the Year 2000 is a leap year. Problems can also

arise earlier than January 1, 2000, as dates in the next millennium are

entered into non-Year 2000 compliant programs.

The Commission views the Year 2000 problem as an extremely serious

issue. A failure to assess properly the extent of the problem,

remediate systems that are not Year 2000 compliant, and then test those

systems could endanger the nation's capital markets and place at risk

the assets of millions of investors. In light of this, both the broker-

dealer industry and the Commission are working hard to address the

industry's Year 2000 problems.

As part of its ongoing efforts relating to the Year 2000, on March

5, 1998, the Commission requested comment on proposed amendments to

Rule 17a-5 \1\ that would require certain broker-dealers to file

reports with the Commission and their DEA regarding Year 2000

compliance.\2\ In particular, the Commission sought comment on: (i) the

definition of the term ``Year 2000 Problem;'' \3\ (ii) the minimum net

capital reporting threshold; (iii) the proposed reporting content; (iv)

the requirement that portions of the report be attested to by

independent public accountants; and (v) the public availability of the

information to be reported.

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

\1\ 17 CFR 240.17a-5. Rule 17a-5 was adopted by the Commission

pursuant to authority under Section 17 of the Exchange Act [15

U.S.C. 78q], and particularly Section 17(e) [15 U.S.C. 78q(e)],

which requires every broker- dealer to file annually with the

Commission a certified balance sheet and income statement, and such

officer information concerning its financial condition as the

Commission may prescribe.

\2\ Release Nos. 34-39724; IC-23059; IA-1704, (March 5, 1998),

63 FR 12056 (March 12, 1998) (''Proposing Release'').

\3\ The Proposing Release defined the term ``Year 2000 Problem''

to include any erroneous result caused by any computer software (i)

incorrectly reading the date ``01/01/00'' or any year thereafter;

(ii) incorrectly identifying a date in the year 1999 or any year

thereafter; (iii) failing to detect that the Year 2000 is a leap

year, and (iv) any other computer error that is directly or

indirectly related to (i), (ii), or (iii) above.

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

The Commission received 35 comment letters in response to the

Proposing Release.\4\ The majority of the commenters generally

supported the Commission's proposals and made suggestions for improving

one or more aspects of the proposed amendments.\5\ However, the

majority of the commenters objected to the attestation requirement and

the $100,000 minimum net capital threshold for determining which

broker-dealers would be required to file Year 2000 reports under the

proposed amendments. The majority of the commenters that addressed the

issue of whether the information reported should be publicly available,

objected to the Year 2000 reports and related accountant's attestation

report being made public. Based on the comments received, the

Commission is adopting the proposed amendments with the changes

discussed below.

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

\4\ All comment letters are available in File No. S7-7-98 at the

Commission's Public Reference Room, 450 Fifth Street, NW,

Washington, DC 20549. The comment period closed on April 27, 1998.

See also Release Nos. 34-39858; IC-23112; IA-1716 (extending the

comment period from April 13, 1998 to April 27, 1998).

\5\ Of the 35 comment letters received, five were opposed to any

additional regulatory requirements.

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

II. Description of the Proposed Rule Amendments

Under the proposed amendments, a broker-dealer that is required to

maintain minimum net capital of $100,000 or greater as of either

December 31, 1997, or December 31, 1998, would have been required to

file two reports at specified times with the Commission and its DEA

regarding its efforts to address Year 2000 Problems. The first of these

reports would have evaluated the efforts of the broker-dealer as of

December 31, 1997, and would have been required to be filed no later

than 45 days after the Commission adopted the proposed rule amendments.

The second report would have evaluated the broker-dealer's efforts as

of the date of its financial statements for fiscal year-end 1998. This

report would have been required to be filed within 90 days after the

date of its fiscal year-end financial statements.

As part of the second report, each reporting broker-dealer would

have been required to make assertions about its efforts to prepare for

the Year 2000. For example, a broker-dealer would have been required to

assert whether or not it has a plan to address Year 2000 Problems. In

addition to making the assertions, each reporting broker-dealer would

have been required to engage an independent public accountant to attest

to whether there was a reasonable basis for the broker-dealer's

assertions.\6\

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

\6\ The broker-dealer's assertions and the related accountant's

attestation report would have been required to be filed only with

the second report.

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

As noted in the Proposing Release, the Commission has advised

broker-dealers that if a broker-dealer's computer systems have Year

2000 Problems, the broker-dealer may be deemed not to have accurate and

current records and be in violation of Rule 17a-3 under the Exchange

Act.\7\ The Commission also reminded broker-dealers that Rule 17a-11

under the Exchange Act requires every broker-dealer to promptly notify

[[Page 37669]]

the Commission of its failure to make and keep current books and

records.\8\

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

\7\ 17 CFR 240.17a-3.

\8\ 17 CFR 240.17a-11(d).

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

III. Discussion of Final Rule Amendments

A. Reporting Threshold

In the Proposing Release, the Commission proposed the $100,000

minimum net capital reporting threshold because broker-dealers subject

to this minimum net capital level are likely to have substantial

financial exposure to the market and to customers. This threshold would

have required all dealers, market makers, and clearing firms to file

the Year 2000 reports.

Several commenters, including the National Association of

Securities Dealers (``NASD''), expressed concern about the proposed net

capital threshold because that threshold excludes nearly 72% of all

registered broker-dealers from reporting on their efforts to address

Year 2000 Problems.\9\ These commenters stated that the Commission's

proposal does not gather adequate information regarding the risks posed

by the Year 2000 because the proposed threshold would exclude many

firms that execute thousands of transactions each trading day effecting

thousands of customers, market makers, and dealers. These commenters

argued that the failure on the part of a large number of excluded

broker-dealers to adequately prepare for the Year 2000 could have

negative systemic effects on the world's financial markets.

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

\9\ As explained in the Proposing Release, under the proposed

$100,000 net capital threshold, approximately 5,600 out of 7,800

registered broker-dealers would be exempt from the Year 2000

reporting requirements.

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

While mindful of the burden on small broker-dealers, the Commission

is addressing this comment by requiring each broker-dealer with a

minimum net capital requirement of $5,000 or greater to file reports

with the Commission and with its DEA that discuss its efforts to

address Year 2000 Problems. Broker-dealers that have a minimum net

capital requirement of less than $100,000 will only be required to file

a less burdensome check-the-box style Year 2000 report. Broker-dealers

that meet a $100,000 minimum net capital reporting threshold will be

required to file, in addition to the check-the-box report, a more

detailed narrative discussion of their Year 2000 efforts. The format

for broker-dealers to report on their efforts to address Year 2000

Problems is discussed in more detail in paragraph III.F. below.

B. Attestation Requirement

The Proposing Release would have required each broker-dealer to

have an independent public accountant attest to several specific

assertions included in the second Year 2000 report. The Commission

believed it was important to have an independent third party affirm

that there was a reasonable basis supporting the broker-dealer's

assertions.

As proposed, each broker-dealer would have been required to assert:

(1) whether it has developed written plans for preparing and

testing its computer systems for potential Year 2000 Problems;

(2) whether the board of directors, or similar body, has approved

these plans, and whether a member of the broker-dealer's board of

directors, or similar body, is responsible for executing the plans;

(3) whether its Year 2000 remediation plans address all domestic

and international operations, including the activities of its

subsidiaries, affiliates, and divisions;

(4) whether it has assigned existing employees, hired new

employees, or engaged third parties to execute its Year 2000

remediation plans; and

(5) whether it has conducted internal and external testing of its

Year 2000 solutions and whether the results of those tests indicate

that the broker-dealer has modified its software to correct Year 2000

problems.

The American Institute of Certified Public Accountants (``AICPA'')

commented that the required attestation report would be difficult for

independent public accountants to provide. The AICPA said that some of

the required broker-dealer assertions are not appropriate for

accountant attestation because the assertions are not capable of

reasonably consistent measurement against reasonable criteria.

Currently, there are no established criteria related to Year 2000

remediation efforts. The lack of established criteria would likely

result in significant variation in the examination procedures performed

by independent public accountants and thus reduce the usefulness of the

attestation reports. In addition, the AICPA expressed concern that the

purpose and conclusions of the attestation report could be

misunderstood. The AICPA was primarily concerned that uninformed users

of the attestation reports would place undue reliance on them.

The AICPA suggested that an ``agreed-upon procedures'' engagement,

instead of an attestation engagement, would more effectively meet the

Commission's goals. Pursuant to such an engagement, a broker-dealer

would engage an independent public accountant to perform and report on

specific procedures designed to meet the Commission's objectives. This

would eliminate the variability of examination procedures performed by

independent public accountants and thus increase the consistency of the

reports received by the Commission. The AICPA's letter outlined

elements of an agreed-upon procedures report and offered to follow-up

with the Commission staff regarding the development of specific

procedures for a Year 2000 engagement.

The Commission is deferring consideration of whether to adopt a

requirement that the second report be evaluated by an independent

public accountant. The Commission, however, will consider such a

requirement if the accounting industry recommends a standard which can

be used by public accountants in connection with the second report.\10\

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

\10\ In light of the AICPA's comment letter and ongoing efforts,

in a companion release also issued today the Commission is re-

opening the comment period with respect to the proposal to have an

independent public accountant review a broker-dealer's second Year

2000 report. The public file (No. S7-7-98) will include both the

AICPA's original comment letter and any follow-up letter submitted

by the AICPA for the Commission's consideration.

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

C. Public Availability

The proposed rules would have made a broker-dealer's Year 2000

reports, including the attestation by the independent public

accountant, available to the public. The Commission recognizes

commenters' concerns that some users of these reports could place undue

reliance on the reports, the technical nature of the reports could

confuse investors, detailed testing reports could be misleading and

unnecessarily alarming, and the reports could contain confidential

proprietary information.

However, the Commission believes that the public's interest is best

served by requiring full and open disclosure. Allowing the public,

particularly other broker-dealers and counterparties, to have access to

the information reported by broker-dealers will enable interested

persons to assess the Year 2000 readiness of a broker-dealer with which

they are doing business. For example, after receiving a counterparty's

report, another broker-dealer might request additional information or

assurances if the counterparty does not appear to be taking the steps

necessary to be Year 2000 compliant. In the absence of such assurances,

the other broker-dealer could determine whether it wishes to

[[Page 37670]]

continue its dealings with that broker-dealer.

Accordingly, the final rule provides that these reports will be

available to the public.

D. Timing

The Proposing Release established as-of dates and due dates for the

reports broker-dealers were required to file.\11\ Some commenters

explained that, in the absence of an existing requirement to make and

retain records detailing Year 2000 remediation efforts as of December

31, 1997, the information to prepare the reports may not be available.

In addition, several commenters stated that reporting Year 2000 status

as of December 31, 1997 would provide data that is outdated and

misleading. Finally, some broker-dealers commented that they have

fiscal years that end in mid to late 1998, and that the proposed due

dates and as-of-dates for the first and second reports would have

required some broker-dealers to file their reports virtually back-to-

back.

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

\11\ The first of these reports would have evaluated the efforts

of broker-dealers as of December 31, 1997, and would have been

required to be filed no later than 45 days after the Commission

adopted the proposed rule amendments. The second report would have

evaluated broker-dealer efforts as of the date of their financial

statements for fiscal year-end 1998. This report would have been

required to be filed within 90 days after the date of their

financial statements.

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

The rule adopted by the Commission today requires a broker-dealer

to file its first report with the Commission and its DEA by August 31,

1998. This report should reflect the status of the broker-dealer's Year

2000 efforts as of July 15, 1998. The second report must be filed with

the Commission and the broker-dealer's DEA by April 30, 1999, and

should reflect the status of the broker-dealer's Year 2000 efforts as

of March 15, 1999.

The rule adopted today also requires new broker-dealers who

register as a broker-dealer between July 16, 1998 and December 31,

1998, to file with the Commission and its DEA no later than 30 days

after its registration becomes effective the first report on its Year

2000 compliance as of the date of its registration. In addition, the

rule also requires new broker-dealers who register as a broker-dealer

between March 16, 1999 and October 1, 1999, to file with the Commission

and its DEA no later than 30 days after its registration becomes

effective a report on its Year 2000 compliance as of the date of its

registration.\12\

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

\12\ New broker-dealers who register between January 1, 1999 and

March 15, 1999, are required to file a report on their Year 2000

efforts no later than April 30, 1999. This report should reflect

their Year 2000 efforts as of March 15, 1999.

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

E. Reporting Requirements

As previously discussed, the Proposing Release would have required

each reporting broker-dealer to discuss the steps it has taken to

address Year 2000 Problems. More specifically, each broker-dealer would

have been required to (i) indicate whether its board of directors, or

similar body, has approved and funded written Year 2000 remediation

plans that address all major computer systems; (ii) describe its Year

2000 staffing efforts, and the work performed by Year 2000 dedicated

staff; \13\ (iii) discuss its progress on each stage of preparation for

the Year 2000; \14\ (iv) indicate if it has written contingency plans

to deal with Year 2000 problems that may occur; \15\ and (v) identify

what levels of management are responsible for Year 2000 remediation

efforts.

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

\13\ This includes whether the broker-dealer has assigned

existing employees, hired new employees, or engaged third parties to

provide assistance in avoiding Year 2000 Problems.

\14\ These stages are: (i) awareness of potential Year 2000

Problems; (ii) assessment of what steps must be taken to avoid Year

2000 Problems; (iii) implementation of the steps needed to avoid

Year 2000 Problems; (iv) internal testing of software designed to

avoid Year 2000 Problems; (v) integrated or industry-wide testing of

software designed to avoid Year 2000 Problems (including testing

with other broker-dealers, other financial institutions, customers,

and vendors); and (vi) implementation of tested software that will

avoid Year 2000 Problems.

\15\ Contingency planning should provide for adequate

protections to ensure the success of critical systems if interfaces

fail or unexpected problems are experienced with operating systems

and infrastructure software. In addition, contingency plans should

provide for the failure of external systems that interact with the

broker-dealer's computer system. For example, contingency plans

should anticipate the failure of a vendor that services mission

critical applications and should provide for the potential that a

significant customer experiences difficulty due to Year 2000

problems.

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

The Securities Industry Association (``SIA'') suggested some

changes to the specific reporting requirements to better clarify the

information sought by the Commission. For example, the Proposing

Release would have required broker-dealers to discuss the work

performed by Year 2000 dedicated staff on an individual basis. In

addition, broker-dealers would have been required to identify the

levels of management involved in the Year 2000 efforts, discuss the

specific responsibilities of these managers, and provide an estimate of

the time they have spent on Year 2000 efforts. The SIA explained that

these proposed requirements may be very burdensome. Fixing Year 2000

problems may require the dedicated efforts of a significant number of

employees and consultants. In addition, the tasks and responsibilities

involved may be detailed, extensive, and constantly changing.

The proposed rule also would have required broker-dealers to report

the number and nature of the exceptions resulting from both internal

and integrated testing of software designed to avoid Year 2000

Problems. The SIA commented that this requirement would likely provide

meaningless information. The SIA explained that testing software is a

dynamic process that in many instances requires exceptions to be

identified hourly, daily, and weekly. In addition, identified

exceptions may be immediately addressed, causing new exceptions to

emerge. This process may repeat itself many times before testing is

finished. Consequently, by the time the Commission received the Year

2000 reports, the exceptions discussed in them may have been addressed

and new exceptions identified.

The Commission agrees that some modification of the reporting

requirements is warranted. The rule adopted today requires each broker-

dealer completing the narrative portion of Form BD-Y2K to provide a

summary of the efforts of Year 2000 dedicated individuals or groups of

individuals. The broker-dealer will not have to provide an estimate of

the time that its management has spent on Year 2000 efforts. Finally,

the broker-dealer must report the number and description of material

exceptions identified during the internal and external testing of its

software that are unresolved as of the report date. The Commission is

leaving the determination of what constitutes a material exception to

the broker-dealer's judgment.

F. Report Format

The Proposing Release would have required each broker-dealer

meeting the $100,000 minimum net capital threshold to discuss, in

narrative format, its efforts to address Year 2000 Problems. The

National Association of Securities Dealers Regulation, Inc. (``NASDR'')

commented that the Commission should prescribe a format for a broker-

dealer to use when reporting on its Year 2000 efforts. More

specifically, the NASDR suggested that the Commission prescribe an

objective reporting format, such as a check-the-box questionnaire. The

NASDR explained that an open narrative format may lead to great

disparity in the nature and detail of the reports that broker-dealers

would submit. Providing a reporting format would produce consistent

results, improve the accuracy and comparability of reports received,

and reduce the time required to

[[Page 37671]]

summarize, track, analyze, and report the information received.

The Commission recognizes the value of receiving the requested

information in an objective format and that prescribing such a format

would decrease the burden that the Year 2000 reporting requirements

impose on broker-dealers. However, the Commission also is concerned

that limiting the reporting requirements to a check-the-box format for

broker-dealers that pose the greatest risk to customers and the market

will not provide the Commission or the DEAs sufficient information to

effectively review for Year 2000 compliance.

The rule the Commission adopts today requires each broker-dealer

with a minimum net capital requirement of $5,000 or greater to file

with the Commission and its DEA Part I of a new Form BD-Y2K.\16\ Part I

of Form BD-Y2K is a check-the-box Year 2000 report that generally

addresses the same issues the proposed narrative discussion addresses.

Each broker-dealer that is required to maintain net capital of $100,000

or greater will be required to file Part II of Form BD-Y2K, which

requires a narrative discussion of its efforts to address Year 2000

Problems. The narrative discussion is designed to provide the

Commission and the DEA's with additional information on the Year 2000

efforts of those broker-dealers who pose the greatest risk to customers

and the market if they are not Year 2000 compliant.

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

\16\ For a copy of Form BD-Y2K see Attachment A.

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

Copies of Form BD-Y2K are available in Commission's Public

Reference Room located at 450 Fifth Street, NW, Washington, DC 20549 or

copies can be obtained from the Commission's internet web site at the

following address: www.sec.gov.

IV. Costs and Benefits of the Rules and Their Effects on

Competition, Efficiency, and Capital Formation

Section 23(a) of the Exchange Act \17\ requires the Commission, in

adopting rules under the Exchange Act, to consider the competitive

effects of such rules and to not adopt a rule that would impose a

burden on competition not necessary or appropriate in furthering the

purposes of the Exchange Act. Furthermore, Section 3(f) of the Exchange

Act \18\ provides that whenever the Commission is engaged in rulemaking

and is required to consider or determine whether an action is necessary

or appropriate in the public interest, the Commission also shall

consider, in addition to the protection of investors, whether the

action will promote efficiency, competition, and capital formation.

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

\17\ 15 U.S.C. 78w (a)(2).

\18\ 15 U.S.C. 78c.

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

The Commission has considered the amendments to Rule 17a-5 in light

of the standards cited in Sections 3 and 23 (a)(2) of the Exchange Act.

In the Proposing Release, the Commission requested that commenters

provide analysis and data supporting the costs and benefits of the

proposed amendments. In addition, the Commission sought comments on the

proposed amendments' effect on competition, efficiency, and capital

formation.

Several commenters indicated that the Commission's cost estimates

were too low. However, no commenters provided detailed information or

data as to the costs of the proposed amendments. One commenter

addressed the issue of whether the proposed amendments would affect

competition. Finally, no comments were received regarding the proposed

amendments effect on efficiency and capital formation.

A. Cost Benefit Analysis

Based on comments received, the Commission has revised the proposed

amendments the result of which is to lower the aggregate cost of

compliance with the rule. As discussed above, the Commission is

adopting new Form BD-Y2K and is expanding the requirement that a

broker-dealer report on its Year 2000 efforts to each broker-dealer

with a minimum net capital requirement of $5,000 or greater. Each of

these broker-dealers is required to file Part I of Form BD-Y2K, a

check-the-box Year 2000 report. Each broker-dealer that meets the

$100,000 minimum net capital reporting threshold is required to also

complete Part II of Form BD-Y2K.

The Commission is also deferring consideration of whether to

require broker-dealers to engage independent public accountants to

examine their efforts to address Year 2000 Problems. The Commission is

allowing broker-dealers to summarize by group the efforts of Year 2000

dedicated individuals as opposed to requiring individual descriptions

of these people's efforts. Broker-dealers will not have to provide an

estimate of the time management has spent on Year 2000 efforts.

Finally, broker-dealers are only required to report the number and

description of unresolved material exceptions identified during the

internal and external testing of their software.

Based on field testing of Part I of Form BD-Y2K conducted by the

Office of Compliance Inspections and Examinations, the Commission

estimates that on average a broker-dealer will spend approximately two

hours completing Part I of Form BD-Y2K resulting in a total cost to the

industry of $2,400,000.\19\ This is based on 6,000 respondents spending

four hours at $100 per hour preparing two reports consisting of Part I

of Form BD-Y2K. The Commission estimates that on average a broker-

dealer will spend 35 hours completing Part II of Form BD-Y2K resulting

in a total cost to the industry of $15,400,000. This is based on 2,200

broker-dealers spending 70 hours at $100 per hour preparing two reports

consisting of Part II of Form BD-Y2K. Therefore, based upon the

adjustments to the proposed rule, the Commission has revised its cost

to the industry to a total of $17,800,000 ($2,400,000 + $15,400,000).

It is important to note that this is a total cost estimate and not an

annual cost. Broker-dealers will only be required to prepare and file

two Form BD-Y2Ks.

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

\19\ Field tests of Part I of Form BD-Y2K indicated that it

could be completed in as little as 30 minutes. However, the

Commission believes that it may take longer for some broker-dealers

to complete Part I of Form BD-Y2K.

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

No commenters addressed the potential benefits of the amendments,

and the Commission has not been able to quantify those benefits.

However, the Commission believes that the benefits will outweigh the

costs. The Commission is aware of the significant effort the securities

industry has put forth and the progress it has made but believes that

significant progress still needs to be made by the securities industry

to be ready for the Year 2000.

The Commission does not yet have comprehensive information

regarding the readiness of the broker-dealer industry for the Year

2000. Although the NASD and the NYSE have conducted surveys of their

members, not all members responded to the survey and some of those who

did submitted incomplete responses. It is important for the Commission

to obtain complete information from individual broker-dealers to permit

the Commission and Self Regulatory Organizations (``SROs'') to assess

the risks associated with firms that fail to show adequate Year 2000

progress. Moreover, the Commission believes that a regulatory

requirement to file Year 2000 reports should encourage broker-dealers

to proceed expeditiously with their efforts to prepare for the Year

2000. The Commission will use the reported information to obtain a more

complete understanding of the industry's overall Year 2000 preparations

and to identify firm-specific and industry-wide problems. Information

in the reports will help the

[[Page 37672]]

Commission focus its Year 2000-related efforts for the rest of 1998 and

1999 on particular industry segments or firms that appear to pose the

greatest risk of non-compliance.

In sum, the rule amendments will enable the Commission to take a

more active role in reducing the Year 2000 risk to the securities

industry. The reports broker-dealers will be required to file will

enable the Commission and the SROs to (i) better monitor the industry's

Year 2000 readiness; (ii) increase broker-dealer awareness that they

should be aggressively preparing for the Year 2000; (iii) coordinate

industry-wide testing, implementation, and contingency planning; and

(iv) enable the Commission to identify potential compliance problems.

B. Efficiency, Competition, and Capital Formation

In the Proposing Release, the Commission stated that the proposed

amendments should not unduly burden competition. One commenter

addressed the proposed amendment's effect on competition. This

commenter stated that the proposed amendments could have an

anticompetitive effect because the amendments exclude nearly 72% of

registered broker-dealers from having to report on their efforts to

address Year 2000 Problems.

The Commission has drafted the rule amendments so as to minimize

their impact on competition. As discussed above, the Commission

adjusted the proposed amendments to require each broker-dealer with a

minimum net capital requirement of $5,000 or greater to report on its

Year 2000 efforts in order to gather adequate information regarding the

industry-wide risks posed by the Year 2000 Problem. However, the

Commission has structured the form of the report to differentiate

between broker-dealers based upon their size, type of business, and

relative risk they pose to customers and the market if they are not

Year 2000 compliant. Broker-dealers that do not meet the $100,000

minimum net capital reporting threshold are only required to file the

Year 2000 report. Broker-dealers that meet the $100,000 minimum net

capital reporting threshold are required to provide additional

information. The Commission believes that the proposed amendments do

not impose any burden on competition not necessary or appropriate in

furtherance of the Exchange Act.

The Commission believes that the amendments should increase the

efficiency and effectiveness of the industry's efforts to prepare for

the Year 2000 by increasing awareness, focusing industry efforts, and

providing critical information for identifying and remedying problems.

In addition, the Commission believes that the amendments do not

adversely affect capital formation. However, failure on the part of the

securities industry to adequately prepare for the Year 2000 could

adversely affect capital formation at the beginning of the next

millennium.

V. Summary of Final Regulatory Flexibility Analysis

A final Regulatory Flexibility Analysis (``FRFA'') concerning the

amendments to Rule 17a-5 has been prepared in accordance with the

provisions of the Regulatory Flexibility Act (``RFA''), as amended by

Pub. L. 104-121, 110 Stat. 847, 864 (1996), 5 U.S.C. 604. The FRFA

notes that the amendments to Rule 17a-5 will enable the Commission to

(i) monitor the steps broker-dealers are taking to address Year 2000

Problems; (ii) increase broker-dealer awareness that they should be

taking specific steps now to prepare for the Year 2000; (iii)

facilitate coordination with SROs on industry-wide testing,

implementation, and contingency planning; and (iv) supplement the

Commission's examination module for Year 2000 issues.

The Commission received no comments on the Initial Regulatory

Flexibility Analysis (``IRFA'') prepared in connection with the

proposing release, and no comment letters specifically addressed the

IRFA. However, as discussed in paragraphs III.A and IV.A above, certain

commenters expressed concern about the threshold for determining which

broker-dealers are required to report on their efforts to prepare for

the Year 2000, and the estimated costs associated with obtaining the

independent public accountant's attestation.

As discussed more fully in the FRFA, the rule will affect small

entities. When used with reference to a broker or dealer, the

Commission has defined the term ``small entity'' to mean a broker or

dealer (``small broker-dealer'') that: (1) had total capital (net worth

plus subordinated liabilities) of less than $500,000 on the date in the

prior fiscal year as of which its audited financial statements were

prepared pursuant to section 240.17a-5(d) or, if not required to file

such statements, a broker or dealer that had total capital (net worth

plus subordinated liabilities) of less than $500,000 on the last

business day of the preceding fiscal year (or in the time that it has

been in business, if shorter); and (2) is not affiliated with any

person (other than a natural person) that is not a small business or

small organization as defined in this release.\20\

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

\20\ 17 CFR 240.0-10(c).

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

Based on FOCUS data for the fourth quarter of 1996, the latest

information available, the Commission estimates that there are

approximately 5,300 small broker-dealers. Of these 5,300 small broker-

dealers, approximately 3,800 are affected by the amendments to Rule

17a-5.\21\

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

\21\ The proposed rule amendments would have affected

approximately 600 small broker-dealers. The reasons for expanding

the Year 2000 reporting requirements are discussed in paragraph

III.A. above.

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

The Commission has drafted the rule amendments so as to minimize

their impact on small broker-dealers while enhancing investor

protection and minimizing any impact on competition, in part, by

adopting different reporting requirements to take into account the

resources available to small broker-dealers. The rule amendments

require broker-dealers with a minimum net capital requirement of $5,000

or greater to report on their efforts to address Year 2000 problems.

However, approximately 1,500 small broker-dealers who do not have a

minimum net capital requirement are exempt from reporting on their Year

2000 efforts. In addition, the Commission has adopted two reporting

formats for broker-dealers to use when reporting on their efforts to

prepare for the Year 2000.

Of the 3,800 small broker-dealers required to report on their Year

2000 efforts, approximately 3,200 (84%) are only required to file a

check-the-box style Year 2000 report. As noted in the cost-benefit

section above, the Commission estimates that it would take each of

these broker-dealers approximately 2 hours to complete the check-the-

box Year 2000 report. The remaining 600 (16%) small broker-dealers are

required to provide, in addition to the check-the-box style report, a

more extensive narrative discussion of their Year 2000 efforts because

the type of business that these broker-dealers conduct poses a greater

risk to customers and the market if they are not Year 2000 compliant.

Thus, by adopting different reporting requirements and by exempting

those broker-dealers who do not have a minimum net capital requirement,

the Commission has imposed no burden, or only a very limited burden, on

approximately 4,700 (89%) small broker-dealers.

The FRFA notes that it would be difficult to further simplify,

consolidate, or adjust compliance standards for small broker-dealers

and be able to effectively monitor the securities industry's efforts

[[Page 37673]]

to prepare for the Year 2000. The Commission believes that the

alternative reporting requirement adopted for small broker-dealers

strikes the appropriate balance between the need to protect investors

and the need to minimize the impact on small broker-dealers. The

Commission also considered the use of performance rather than design

standards. However, the Commission concluded that it would be

inconsistent with the purpose of the rule to use performance standards

to specify different requirements for small entities.

A copy of the FRFA may be obtained by contacting Christopher M.

Salter, Staff Attorney, U.S. Securities and Exchange Commission, Mail

stop 10-1, 450 Fifth Street, NW., Washington, DC 20549.

VI. Paperwork Reduction Act

As set forth in the Proposing Release, the amendments to Rule 17a-5

contain collections of information within the meaning of the Paperwork

Reduction Act of 1995 (``PRA'').\22\ Accordingly, the collection of

information requirements were submitted to the Office of Management and

Budget (``OMB'') for review and were approved by OMB which assigned the

following control number 3235-0511.

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

\22\ 44 U.S.C. 3501 et seq.

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

The Proposing Release solicited comments on the proposed

collections of information. No comments were received that specifically

addressed the PRA submission. However, as discussed in sections III.

and IV. above, the Commission received suggestions that would improve

the collections of information. Based upon these suggestions, the

collections of information have been adjusted as described in sections

III. above and are in accordance with Section 3507 of the PRA.\23\

These adjustments include the adopting of two reporting formats to

increase the consistency, accuracy and comparability of the information

collected. In addition, the adjustments will reduce the time required

to summarize, track, analyze, and report the information received.

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

\23\ 44 U.S.C. 3507.

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

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the agency displays a

valid OMB control number. Broker-dealers are required to comply with

the collection of information pursuant to the amendments to Rule 17a-5

and the information is necessary to provide the Commission with a

better understanding of the security industry's readiness for the Year

2000. The information collected pursuant to the amendments to Rule 17a-

5 will be public.

Based upon the adjustments to the amendments, the Commission is

adjusting its burden estimate. The Commission estimated in the

Proposing Release that, on average, a broker-dealer would spend 70

hours preparing the Year 2000 report and obtaining the independent

public accountant's Attestation. The Commission estimates that under

the final amendments, a broker-dealer will, on average, spend two hours

preparing Part I of Form BD-Y2K and 35 hours preparing Part II of Form

BD-Y2K. The total annualized burden to the securities industry is

estimated to be 89,000 hours. This is based on 6,000 respondents

spending two hours preparing Part I and 2,200 respondents spending 35

hours preparing Part II of Form BD-Y2K.

VII. Statutory Analysis

Pursuant to the Securities Exchange Act of 1934 and particularly

Sections 17(a) and 23(a) thereof, 15 U.S.C. 78o(c)(3) and 78w, the

Commission is adopting amendments to Sec. 240.17a-5 of Title 17 of the

Code of Federal Regulations in the manner set forth below.

List of Subjects in 17 CFR Parts 240 and 249

Broker-dealers, Reporting and recordkeeping requirements,

Securities.

Text of Final Rule

In accordance with the foregoing, Title 17, chapter II, part 240 of

the Code of Federal Regulations is amended as follows:

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

1934.

1. The authority citation for part 240 continues to read in part as

follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee,

77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k,

78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d),

78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and

80b-11, unless otherwise noted.

* * * * *

2. By amending Sec. 240.17a-5 by adding paragraph (e)(5) to read as

follows:

Sec. 240.17a-5 Reports to be made by certain brokers and dealers.

* * * * *

(e) Nature and form of reports. * * *

(5)(i) For purposes of this section, the term Year 2000 Problem

shall include problems arising from:

(A) Computer software incorrectly reading the date ``01/01/00'' as

being the year 1900 or another incorrect year;

(B) Computer software incorrectly identifying a date in the Year

1999 or any year thereafter;

(C) Computer software failing to detect that the Year 2000 is a

leap year; or

(D) Any other computer software error that is directly or

indirectly caused by the problems set forth in paragraph (e)(5)(i)(A),

(B), or (C) of this section.

(ii) (A) No later than August 31, 1998, every broker or dealer

required to maintain minimum net capital pursuant to Sec. 240.15c3-

1(a)(2) of $5,000 or greater as of July 15, 1998, shall file Part I of

Form BD-Y2K (Sec. 249.618 of this chapter) prepared as of July 15,

1998, and no later than April 30, 1999, every broker or dealer required

to maintain minimum net capital pursuant to Sec. 240.15c3-1(a)(2) of

$5,000 or greater as of March 15, 1999, shall file Part I of Form BD-

Y2K prepared as of March 15, 1999.

(B) Every broker or dealer that registers pursuant to section 15 of

the Act between July 16, 1998 and December 31, 1998 or between March

16, 1999 and October 1, 1999, and that is required to maintain net

capital pursuant to Sec. 240.15c3-1(a)(2) of $5,000 or greater, shall

file Part I of Form BD-Y2K (Sec. 249.18 of this chapter) no later than

30 days after its registration becomes effective. Part I of Form BD-Y2K

shall be prepared as of the date its registration became effective.

(iii)(A) No later than August 31, 1998, every broker or dealer with

a minimum net capital requirement pursuant to Sec. 240.15c3-1(a)(2) of

$100,000 or greater as of July 15, 1998 shall file Part II of Form BD-

Y2K (Sec. 249.618 of this chapter). Part II of Form BD-Y2K shall

address each topic in paragraph (e)(5)(iv) of this section as of July

15, 1998.

(B) No later than April 30, 1999, every broker or dealer with a

minimum net capital requirement pursuant to Sec. 240.15c3-1(a)(2) of

$100,000 or greater as of March 15, 1999 shall file Part II of Form BD-

Y2K (Sec. 249.618 of this chapter). In addition, each broker or dealer

subject to paragraph (e)(5)(iii)(A) of this section shall file Part II

of Form BD-Y2K pursuant to this paragraph (e)(5)(iii)(B) regardless of

its minimum net capital requirement. Part II of Form BD-Y2K shall

address each topic in paragraph (e)(5)(iv) of this section as of March

15, 1999.

(C) Every broker or dealer that registers pursuant to section 15 of

the Act between July 15, 1998 and December 31, 1998 or between March

[[Page 37674]]

16, 1999 and October 1, 1999, and that is required to maintain net

capital pursuant to Sec. 240.15c3-1(a)(2) of $100,000 or greater, shall

file Part II of Form BD-Y2K (Sec. 249.18 of this chapter) no later than

30 days after registration becomes effective. Part II of Form BD-Y2K

shall address each topic in paragraph (e)(5)(iv) of this section as of

the effective date of its registration.

(iv) Part II of Form BD-Y2K (Sec. 249.618 of this chapter) prepared

pursuant to paragraph (e)(5)(iii) of this section shall identify a

specific person or persons that are available to discuss the contents

of the report and shall include a discussion of the following:

(A) Whether the board of directors (or similar body) of the broker

or dealer has approved and funded plans for preparing and testing its

computer systems for Year 2000 Problems;

(B) Whether the plans of the broker or dealer exist in writing and

address all mission critical computer systems of the broker or dealer

wherever located throughout the world;

(C) Whether the broker or dealer has assigned existing employees,

hired new employees, or engaged third parties to provide assistance in

addressing Year 2000 Problems, and if so, a description of the work

that these groups of individuals have performed as of the date of each

report;

(D) The current progress of the broker or dealer on each stage of

preparation for potential problems caused by Year 2000 Problems. These

stages are:

(1) Awareness of potential Year 2000 Problems;

(2) Assessment of what steps the broker or dealer must take to

address Year 2000 Problems;

(3) Implementation of the steps needed to address Year 2000

Problems;

(4) Internal testing of software designed to address Year 2000

Problems, including the number and a description of the material

exceptions resulting from such testing that are unresolved as of the

reporting date;

(5) Point-to-point or industry-wide testing of software designed to

address Year 2000 Problems (including testing with other brokers or

dealers, other financial institutions, and customers), including the

number and a description of the material exceptions resulting from such

testing that are unresolved as of the reporting date; and

(6) Implementation of tested software that will address Year 2000

Problems;

(E) Whether the broker or dealer has written contingency plans in

the event, that after December 31, 1999, it has problems caused by Year

2000 Problems;

(F) What levels of management of the broker or dealer are

responsible for addressing potential problems caused by Year 2000

Problems, including a description of the responsibilities for each

level of management regarding the Year 2000 Problems;

(G) Any additional material information concerning its management

of Year 2000 Problems that will help the Commission and the designated

examining authorities assess the readiness of the broker or dealer for

the Year 2000.

(v) The broker or dealer shall file an original and two copies of

Form BD-Y2K (Sec. 249.618 of this chapter) prepared pursuant to

paragraph (e)(5) of this section with the Commission's principal office

in Washington, D.C. and one copy of Form BD-Y2K with the designated

examining authority of the broker or dealer. The reports required by

paragraph (e)(5) of this section shall be public.

* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

3. The authority citation for part 249 continues to read in part as

follows:

Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;

* * * * *

4. By adding Sec. 249.618 and Form BD-Y2K to read as follows.

Sec. 249.618 Form BD-Y2K, information required of broker-dealers

pursuant to section 17 of the Securities Exchange Act of 1934 and

Sec. 240.17a-5 of this chapter.

This form shall be used by every broker-dealer required to file

reports under Sec. 240.17a-5(e) of this chapter.

Note: Form BD-Y2K does not appear in the Code of Federal

Regulations. Form BD-Y2K is attached as Appendix A to this document.

By the Commission.

Dated: July 2, 1998.

Margaret H. McFarland,

Deputy Secretary.

BILLING CODE 8010-01-P

[[Page 37675]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.000

[[Page 37676]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.001

[[Page 37677]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.002

[[Page 37678]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.003

[[Page 37679]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.004

[[Page 37680]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.005

[[Page 37681]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.006

[[Page 37682]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.007

[[Page 37683]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.008

[[Page 37684]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.009

[[Page 37685]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.010

[[Page 37686]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.011

[[Page 37687]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.012

[[Page 37688]]

[GRAPHIC] [TIFF OMITTED] TR13JY98.013

[FR Doc. 98-18292 Filed 7-10-98; 8:45 am]

BILLING CODE 8010-01-E