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

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-40518; File No. S7-26-98]

RIN 3235-AH04

Books and Records Requirements for Brokers and Dealers Under the

Securities Exchange Act of 1934

AGENCY: Securities and Exchange Commission.

ACTION: Reproposed rule.

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SUMMARY: The Securities and Exchange Commission is reproposing for

comment amendments to its broker-dealer books and records rules, Rule

17a-3 and Rule 17a-4, under the Securities Exchange Act of 1934. The

original proposal was made in 1996 in response to concerns raised by

members of the North American Securities Administrators Association

about the adequacy of the Commission's books and records rules as to

sales practices. The reproposed amendments incorporate comments

received in response to the original proposal. These amendments are

designed to clarify and expand recordkeeping requirements with respect

to purchase and sale documents, customer records, associated person

records, customer complaints, and certain other matters. The reproposed

amendments also specify the books and records that broker-dealers would

have to make available at their local offices. The reproposed books and

records rules are specifically designed to assist securities regulators

when conducting sales practice examinations.

DATES: Comments must be received on or before November 9, 1998.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,

N.W., Mail Stop 6-9, Washington, D.C. 20549. Comments may also be

submitted electronically at the following E-mail address: rule-

[email protected]. All comment letters should refer to File No. S7-26-

98. All comments received will be available for public inspection and

copying in the Commission's Public Reference Room, 450 Fifth Street,

N.W., Washington, D.C. 20549. Electronically

[[Page 54405]]

submitted comment letters will be posted on the Commission's Internet

web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate

Director, at (202) 942-0131; Thomas K. McGowan, Assistant Director, at

(202) 942-4886; or Deana A. La Barbera, Attorney, at (202) 942-0734;

Office of Risk Management and Control, Division of Market Regulation,

Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop

10-1, Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

Section 17(a)(1) of the Securities Exchange Act of 1934 (``Exchange

Act'') 1 requires registered broker-dealers to make, keep,

furnish, and disseminate records and reports prescribed by the

Commission ``as necessary or appropriate in the public interest, for

the protection of investors, or otherwise in furtherance of the

purposes of'' the Exchange Act.2 Rules 17a-3 and 17a-4 under

the Exchange Act specify minimum requirements with respect to the

records that broker-dealers must make as well as the periods during

which those records and other documents relating to the broker-dealer's

business must be preserved.3 The Commission, self-regulatory

organizations (``SROs''), and state securities regulators must have

timely access to these records to conduct effective examinations and

enforcement actions.

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\1\ 15 U.S.C. 78a et seq.

\2\ 15 U.S.C. 78q(a)(1).

\3\ 17 CFR 240.17a-3 and 240.17a-4.

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The reproposed recordkeeping requirements are intended to enable

securities regulators to conduct more efficient and effective broker-

dealer examinations primarily for compliance with sales practice

requirements. For situations in which examiners uncover potential

violations of law, the reproposed recordkeeping requirements would

provide regulators with essential tools for enforcement investigations,

and, when necessary, enforcement proceedings. In addition, the

reproposed amendments that would require that records be kept at each

local office of a broker-dealer would improve the ability of securities

regulators, including state securities regulators, to conduct

examinations of sales practice activities of individual offices of a

broker-dealer.

In 1993, the North American Securities Administrators Association

(``NASAA''), through its Broker-Dealer Operations Committee (``NASAA

Committee''), commenced work on a model state regulation that would

require broker-dealers to make and preserve books and records that

would be valuable in examination and enforcement proceedings. The NASAA

Committee presented a final draft of its model regulation for

membership approval at NASAA's October 1995 meeting. At that meeting,

the Commission's Chairman, Arthur Levitt, stated that supplemental

state books and records requirements would impose a substantial burden

on broker-dealers because of the possibility that each state's

requirements would be inconsistent with those adopted by other states

and that modification of the Commission's rules would be a less

burdensome means of accomplishing NASAA's goals. At Chairman Levitt's

request, NASAA's membership voted to defer taking further action with

respect to the NASAA Committee's proposed model regulations to give the

Commission an opportunity to develop appropriate amendments to its

books and records rules.

On October 11, 1996, the National Securities Market Improvement Act

of 1996 (``NSMIA'') was adopted.4 NSMIA prohibited states

from establishing books and records rules that differ from, or are in

addition to the Commission's rules.5 NSMIA also provided

that the Commission must consult periodically with state securities

regulators concerning the adequacy of the Commission's books and

records rules.6

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\4\ Pub. L. 104-290, 110 Stat. 3416 (1996).

\5\ 15 U.S.C. 78o(h).

\6\ Id.

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II. Proposing Release

On October 22, 1996, the Commission proposed amendments

7 to the books and records rules that were designed to

further the Commission's role in protecting investors and to address

the NASAA Committee's concern that the Commission's current books and

records requirements do not obligate broker-dealers to make and retain

records specifically designed to facilitate sales practice examinations

and enforcement activities.

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\7\ Exchange Act Release No. 37850 (Oct. 22, 1996), 61 FR 55593

(Oct. 28, 1996) (``Proposing Release'').

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The amendments to Rule 17a-3 proposed in 1996 would have required

broker-dealers to generate local office blotters, record supplemental

information on brokerage order memoranda, create customer account

forms, and maintain additional records concerning associated persons,

customer complaints, and exceptional activity in customer accounts. The

proposed amendments to Rule 17a-4 would have required broker-dealers to

preserve additional records, including advertising and marketing

materials, registrations and licenses, audit and examination reports,

records concerning recommended securities, and manuals relating to

compliance, supervision, and procedures. Further, the proposed

amendments to Rule 17a-4 would have clarified and modified the

Commission's existing requirements concerning preservation of certain

correspondence and contracts. Finally, the proposed amendments to Rule

17a-4 would have supplemented the existing standards concerning the

organization of books and records, required broker-dealers to designate

a principal to be responsible for books and records compliance, and

required broker-dealers to make certain records available at each of

their local offices.

The Commission received approximately 178 written comments in

response to the Proposing Release. Broker-dealers, trade associations,

and law firms representing broker-dealers submitted 110 comment letters

generally opposing some or all of the proposed amendments. State

securities regulators and NASAA accounted for 33 comment letters

generally supporting the proposed amendments. The balance of the

comment letters were received from other individuals or entities

interested in the Proposing Release.

Most broker-dealers opposed the proposed amendments because they

believed the costs associated with implementing them would outweigh any

increase in investor protection. Many broker-dealer commenters

particularly opposed the proposed amendments requiring certain records

to be kept at each local office and suggested that the records be

maintained at one centralized location with the understanding that the

records would be provided to regulators at a local office on a timely

basis. Some broker-dealers were particularly concerned with the local

office retention requirement because it would apply to one-person

offices. These broker-dealers believed that these offices could be more

effectively supervised if records were held at one centralized

location. Small broker-dealers and those affiliated with insurance

companies suggested that they be exempt from the provisions of the

proposed amendments.

The letters submitted by the state securities regulators and NASAA,

on the other hand, strongly supported the proposed amendments in their

entirety. These commenters believed that the amendments would enable

state securities regulators to conduct more thorough and efficient

broker-dealer

[[Page 54406]]

examinations, particularly of local offices in their respective states.

NASAA commented that state-level examinations have revealed that

broker-dealers, hearing officers, and state courts had divergent

interpretations of the Commission's books and records rules, that state

examinations were often hindered by the absence of key records in local

offices, that many branch records were poorly organized and

inefficiently maintained, and that where records were maintained at a

central location, there often were significant delays in the production

of requested records. These commenters believed the amendments to Rules

17a-3 and 17a-4 would enable state securities regulators to more

effectively conduct broker-dealer examinations, especially examinations

of local branch offices of broker-dealers operating in their respective

states.

III. Reproposed Amendments and Discussion

In response to numerous comments, the Commission is reproposing the

amendments, which have been modified from the original proposal, to

reduce the burden on broker-dealers without substantially detracting

from the original objective of establishing rules that would facilitate

examinations and enforcement activities of the Commission, SROs, and

state securities regulators. Some of the reproposed rules may be

duplicative of SRO recordkeeping rules; 8 nevertheless, the

Commission is reproposing the rules because it believes certain

recordkeeping requirements should be directly enforced by the

Commission and should be available for states to include under their

own laws.

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\8\ For example, the Commission would require broker-dealers to

maintain information, such as investment objectives, about customers

that would overlap certain provisions of National Association of

Securities Dealers (``NASD'') Conduct Rule 3110 and New York Stock

Exchange (``NYSE'') Rule 405.

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A. Memoranda of Brokerage Orders and Dealer Transactions

Rules 17a-3(a)(6) and 17a-3(a)(7) currently require that brokerage

order memoranda and dealer purchase and sale memoranda (``order

tickets'') include information concerning the terms and conditions of

the order, the account for which the order is entered, the time of

entry, the execution price, and to the extent feasible, the time of

execution (or cancellation) of the order.9 The Proposing

Release would have required that each order ticket also identify the

associated person who entered the order and indicate whether the order

was solicited or unsolicited.

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\9\ A number of firms have asked for guidance on the meaning of

the term ``to the extent feasible.'' The time of execution should be

included on the order ticket except for situations in which it may

be impossible to determine the precise time when the transaction was

executed; however, in that case the broker-dealer must note the

approximate time of execution. Exchange Act Release No. 3040 (Oct.

13, 1941), 11 FR 10984.

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As reproposed, an order ticket would still have to identify the

associated person who entered the order, but it would not have to note

whether the transaction was solicited or unsolicited. Further, the

reproposed amendments to Rules 17a-3(a)(6) and (7) would require that

an order ticket contain the identity of any person, other than the

associated person, who entered or accepted the order on behalf of a

customer. This requirement would allow securities examiners to

determine whether particular persons, including unregistered persons,

are engaged in sales practice violations.

The reproposed amendments provide flexibility in how a broker-

dealer would have to record the identity of the person entering the

order. Under the reproposed amendments, if a broker-dealer uses an

electronic system to generate order tickets that does not have a field

available to capture the identity of a person, other than the

associated person, entering an order on a customer's behalf, the

broker-dealer would not have to modify its system to enter that detail

on the order ticket; alternatively, the broker-dealer could create a

separate record identifying the person.

The Commission seeks comment on how this rule should be applied to

firms whose customers use an e-mail address, an electronic trading

system, a general telephone number, or other system or procedure to

submit orders. The Commission also seeks comment on whether certain

firms, such as firms that accept unsolicited orders only or firms that

do not designate a specific associated person for each account, should

be exempt from this rule.

The reproposed amendments also would add a requirement that a

broker-dealer record on the order ticket the time at which the broker-

dealer receives a customer order, even if the order is subsequently

executed. The current rule requires this information only when the

order is not executed. This amendment would enable examiners to review

more easily a broker dealer's compliance with its best execution

obligations and the requirement that a broker-dealer not trade ahead of

its customers.10

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\10\ See 17 CFR 240.11Ac1-1 and 240.11Ac1-4. See also NASD

Conduct Rules 2110 and 2320.

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B. Additional Records Concerning Associated Persons

Rule 17a-3(a)(12) currently specifies the types of records that a

broker-dealer must maintain with respect to each of its associated

persons. In addition to basic background information, the existing rule

requires a broker-dealer to maintain records of each associated

person's employment and disciplinary history. The Proposing Release

would have required that each broker-dealer keep additional records

concerning its associated persons, including registration and licensing

materials, and that certain of these records be kept at each local

office.

The reproposed amendments would not require that Forms U-4 and U-5,

amendments to those forms, or state or SRO licenses be kept at local

offices of the broker-dealer, or that a broker-dealer maintain records

concerning an associated person's change in licensing status. As

several commenters pointed out, this information is readily available

through the Central Registration Depository (``CRD'').

The proposed amendments also would have required that each broker-

dealer maintain records with respect to agreements between associated

persons and the broker-dealer, customer complaint information, and

client trading records for each associated person. The reproposal

largely retains these requirements albeit in new proposed subsections

of the rule.11 These requirements would assist examiners in

reviewing the sales practices of individual associated persons.

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\11\ The requirement regarding customer complaints has been

moved to reproposed Rule 17a-3(a)(17). Other requirements relating

to records for each associated person have been moved to Reproposed

Rule 17a-3(a)(12) so that most of the records required to be kept

about associated persons are located in the same paragraph of Rule

17a-3.

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The reproposed amendments would require that each broker-dealer

maintain a list of any internal identification numbers and CRD numbers

assigned to associated persons and a list of associated persons working

at, out of, or being supervised at or from each local

office.12 This information will assist examiners especially

with respect to conducting an examination of a particular local office.

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\12\ The proposed amendments would have required broker-dealers

to maintain a list identifying the local office where each

associated person conducts the greatest portion of his or her

business. This provision has been discarded in favor of the

reproposed amendments to Rule 17a-3(a)(12).

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Finally, the reproposed amendments would delete the definition of

associated person from Rule 17a-

[[Page 54407]]

3(a)(12)(ii). Given that the term associated person is defined in

several provisions of the Exchange Act, a separate definition under the

rule is unnecessary and potentially confusing.13 Exchange

Act provisions essentially define an associated person to include any

partner, officer, director, or branch manager of a broker-dealer, and

any person occupying a similar status or performing similar functions.

In addition, the term associated person includes any person directly or

indirectly controlling, controlled by, or under common control with a

broker-dealer, or any employee of a broker-dealer. The Commission

interprets the term associated person to include any independent

contractor, consultant, franchisee, or other person providing services

to a broker-dealer equivalent to those services provided by the persons

specifically referenced in the statute.14 Consistent with

this position, the reproposed amendments would require broker-dealers

to keep records regarding all such persons.

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\13\ See Sections 3(a)(18) and (21). See also Sections 3(a)(32)

and 3(a)(45).

\14\ The Commission has taken the position that independent

contractors involved in the sale of securities on behalf of a

broker-dealer (who are not themselves registered as broker-dealers)

must be ``controlled by'' the broker-dealer, and, therefore, are

associated persons of the broker-dealer. See, e.g., In the Matter of

William v. Giordano, 61 S.E.C. Dkt. 345, Exchange Act Release No.

36742 (Jan. 19, 1996)(In finding that an officer of a broker-dealer

firm failed reasonably to supervise an independent contractor, the

Commission found that the independent contractor was an ``associated

person'' of the firm within the meaning of Section 3(a)(18) of the

Exchange Act). See also Letter from SEC Division of Market

Regulation, to Gordon S. Macklin, NASD; Charles J. Henry, CBOE;

Robert J. Birnbaum, AMEX; and John J. Phelan, NYSE, [1982-1983

Transfer Binder] Fed. Sec. L. Rep. (CCH) P77,303 at 78,116 (June 18,

1982); Hollinger v. Titan Capital Corp., 974 F.2d 1564, 1572-76 (9th

Cir. 1990), cert. denied, 111 S. Ct. 1621 (1991). A similar analysis

would be applicable to other persons, such as consultants and

franchisees, performing securities activities with or for the

broker-dealer.

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These records would not be required, however, for persons whose

functions are solely clerical, ministerial, or not directly related to

the securities business. For example, records would need to be retained

for a consultant performing duties equivalent to those of an officer or

a director of a broker-dealer, such as a chief financial officer;

however, no records would be required for a consultant providing

services related to a broker-dealer's health care plan. These records

would be useful in determining whether individuals affiliated with a

broker-dealer are engaged in sales activities and whether individuals

who have been barred from association with broker-dealers are

continuing their association.

C. Customer Account Records

The proposed amendments would have required broker-dealers to

maintain for each customer account an account form that included basic

identification and background information about the customer, including

the customer's investment objectives. The Commission is reproposing

Rule 17a-3(a)(16) with certain modifications to reflect the comments

received regarding the proposed rule.

The reproposed amendments replace the term ``account form'' with

``record of each account of a customer.'' The term was changed in

response to comments that the word ``form'' could be interpreted to

mean paper records only and that many broker-dealers store customer

information electronically.

The reproposed amendments would apply only to accounts that have

natural persons as the beneficial owners. With respect to joint

accounts composed of natural persons, the Commission specifically

solicits comment as to whether the required information should be kept

for each individual participant in a joint account or only for those

individuals with authority to execute transactions in the account.

As proposed, if a customer's investment objectives included

speculation or other high risk objectives, the broker-dealer would have

had to record the percentage of the customer's investment capital

dedicated to such objectives. The proposed rule also would have

required that the portion of the account form regarding the customer's

investment objectives be updated annually. In response to this

proposal, many commenters stated that a customer's investment

objectives can change frequently; thus, a record of specific investment

objectives could quickly become inaccurate. Commenters also stated that

using the phrase ``speculation or similar high-risk objective'' to

categorize a customer's investment objectives would be imprecise. The

reproposed amendments would still require that a customer's investment

objectives or risk tolerance be noted; however, as reproposed, each

broker-dealer would be able to use whatever formulation it chooses to

categorize each customer's investment objectives or risk tolerance.

Further, the reproposed amendments would not require that a customer's

investment objectives be updated annually; rather, as discussed below,

the investment objectives would need to be updated at least once every

36 months. These requirements would allow examiners to more effectively

review for compliance with suitability requirements.

The Proposing Release would have required broker-dealers to furnish

to each customer a copy of the customer's account form within 30 days

of the first trade for the account or within 30 days of a change or

correction to the contents of the account form. The reproposed

amendments modify the original proposal and would require that the

customer account record be furnished to a customer within 30 days of

opening the account and thereafter at least once every 36 months or

when the account record is updated to reflect a change in the

customer's name, address, or investment objectives. This requirement

would provide customers the opportunity to verify and update the

information in their records and correct any misunderstandings or

errors. If the account record is updated to reflect a change of

address, the broker-dealer would have to furnish the account record to

the new address and a notice of the change of address to the old

address. The Commission requests comment on whether a broker-dealer

should include a customer's social security number when sending an

updated account record to the customer.

The neglect, refusal, or inability of a customer to provide or

update any required information for the customer's account record would

excuse the broker-dealer from obtaining the required information.

However, when opening the customer account, the broker-dealer would be

required to make a record of the explanation for the absence of the

information. Although the customer's refusal to provide this

information to the broker-dealer would excuse the firm from obtaining

the information under proposed rule 17a-3(a)(16), the firm would still

be required to comply with any applicable securities regulatory

authority rules regarding obtaining customer information.

For accounts existing on the effective date of the rule, the 36

month period would begin on the effective date of the rule amendment.

If a customer's name, address, or investment objectives do not change

within that 36 month period, the broker-dealer would have to furnish to

the customer a copy of the customer's updated account record no later

than 36 months from the effective date of the amendment. If a

customer's name or address does change during the period, however, the

broker-dealer would have to furnish to the customer a copy of the

customer's updated account record within 30 days of the customer

informing the broker-dealer of the change. In this situation, a new 36

month period would begin on the date

[[Page 54408]]

the updated information is furnished to the customer, provided, the

entire account record is furnished to the customer. Likewise, any other

subsequent change in the customer's name or address also would begin a

new 36 month period.

For an account opened after the effective date of this rule

amendment, the broker-dealer would be required to send an account

record within 30 days of the opening of the account. Thereafter, the 36

month period would begin on the date the account is opened.

Additionally, a new 36 month period would begin any time a broker-

dealer furnishes a complete updated account record to a customer.

Broker-dealers would be free, of course, to update account record

information more frequently than the rule requires.

Reproposed Rule 17a-3(a)(16) would add a requirement that

information be kept as to whether the customer is an associated person

of a broker-dealer. If an account is a discretionary account, the

record would have to contain the dated signature of each customer

granting the discretionary authority over the account and the dated

signature of each person to whom discretionary authority was granted.

These requirements would assist examiners in identifying possible

trading or sales practice violations, such as churning, trading ahead

of customers, front-running, or possible manipulative activities

involving controlled or nominee accounts.

The reproposed amendments would also require a broker-dealer to

create a record indicating whether it has complied with applicable

securities regulatory authority rules governing the information

required when opening or updating a customer account.15 This

provision, for example, would apply to Exchange Act Rule 15g-9 which

requires broker-dealers to follow certain procedures before effecting

customer transactions in the penny stock market, Municipal Securities

Rulemaking Board Rule G-8(a)(xi) which requires broker-dealers and

municipal securities dealers to obtain certain customer information

before effecting transactions in municipal securities, NASD Rule 3110

which requires broker-dealers to maintain certain customer account

information, such as a customer's address and residence, NASD Rule

2860(b)(16) regarding the opening of options accounts, NASD Rule 2310

regarding information that must be obtained prior to making investment

recommendations to customers, NYSE Rule 405 which requires NYSE members

to use due diligence to learn the essential facts relative to every

customer, and Chicago Board of Options Exchange Rule 9.7 which sets

forth the requirements for opening a customer options account. This

requirement would help the Commission staff and state securities

regulators in reviewing for compliance with securities regulatory

authority rules relating to customer information and sales practice

violations. The Commission requests comment on whether there are other

SRO or Commission rules relating to opening or updating customer

accounts that would or should be included under this proposed

recordkeeping requirement. Because many broker-dealers likely already

keep such records, would this requirement impose any additional burden

on broker-dealers? Are there any alternatives that would be less

burdensome?

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\15\ Reproposed Rule 17a-3(a)(16)(ii).

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D. Customer Complaints

The Proposing Release would have required broker-dealers to

maintain files of written materials relating to customer complaints and

to make and keep written memoranda of oral customer complaints alleging

certain types of fraud and theft. The reproposed amendments would not

require broker-dealers to document oral complaints or require each

local office to maintain a customer complaint file of all

correspondence, memoranda, and other documents received in connection

with the complaint. Instead, each broker-dealer would have to keep a

record of written complaints against each associated

person.16 In addition, a broker-dealer would have to

maintain for each local office a record of written complaints against

each associated person that conducts business at that local

office.17 The records would have to include, among other

things, a description of the nature of the complaint, the name of the

complainant, and the disposition of the complaint. As an alternative to

maintaining a record of each customer complaint, a broker-dealer may

keep a copy of the written complaint along with a record of the

disposition of the complaint. These complaint retention requirements

would enable examiners to detect patterns of customer abuses, both

within particular offices and firm wide.

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\16\ Reproposed Rule 17a-3(a)(17).

\17\ See Reproposed Rule 17a-3(f).

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Reproposed Rule 17a-3(a)(17)(ii) would require that broker-dealers

create a record indicating that each customer has been notified of the

address and telephone number of the department of the broker-dealer to

which any complaints may be directed. This requirement would expand on

an existing interpretation of the Commission's financial responsibility

rules and the Securities Investor Protection Act of 1970, which states

that, for purposes of custody of securities, for a broker-dealer to

qualify as an introducing firm, its customers must be treated as

customers of the clearing firm.18 Furthermore, under that

interpretation, the clearing firm must issue account statements

directly to customers and each account statement must contain the name,

address, and telephone number of a responsible individual at the

clearing firm whom a customer can contact with inquiries and complaints

regarding the customer's account. This reproposed requirement would

apply to all firms carrying or clearing customer accounts in addition

to those firms in an introducing/clearing arrangement.

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\18\ Exchange Act Release No. 31511 (Nov. 24, 1992), 57 FR 56973

(Dec. 2, 1992).

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E. Other Required Records

The Proposing Release would have required broker-dealers to create

commission and compensation records for each associated person. The

reproposed amendments would require essentially the same information as

originally proposed, but would allow broker-dealers greater flexibility

in how they can retain the records.19 For example, in lieu

of retaining the individual compensation records, broker-dealers would

be permitted to store electronically the data necessary to produce the

records.20 Broker-dealers that choose this option would be

required to produce the records upon request. Additionally, the

reproposed amendments would clarify that records must be kept for non-

monetary as well as monetary compensation. This would assist examiners

in detecting sales practice violations tied to a firm's compensation

practices.

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\19\ Reproposed Rule 17a-3(a)(18).

\20\ See Reproposed Rule 17a-3(f).

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The Proposing Release would have required broker-dealers to produce

reports to monitor unusual occurrences in customer accounts such as

frequent trading, unusually high commissions, or an unusually high

number of trade corrections or cancellations. The reproposed amendments

would not require broker-dealers to make these types of reports, but

instead, would require broker-dealers to retain these reports, if

created, or be able to recreate them upon request.21 Because

this provision would now be a record

[[Page 54409]]

retention requirement, it has been moved to Rule 17a-4. These

requirements would assist examiners in identifying violations such as

churning and unauthorized trading. The Commission requests comment on

whether the requirement that these reports be kept for three years is

appropriate.

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\21\ Reproposed Rule 17a-4(b)(11).

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F. Local Office

The definition of a local office is significant because broker-

dealers must create records regarding activities in each local office

and maintain a copy of certain records at that local office. This

section discusses the reproposed definition of local office, the

records that would be required to be maintained at each local office,

alternative means of record retention for local offices, and state

record depositories for those offices that do not qualify as local

offices.

1. Definition of Local Office

The reproposed amendments would modify the definition of ``local

office'' to include locations where two or more associated persons

regularly conduct a securities business.22 This definition

has been modified from the Proposing Release, which would have included

one-person offices in the definition, primarily in response to comments

from broker-dealers that have many one-person offices or have

associated persons who work from their homes. In these instances,

records currently are stored at centralized locations maintained by the

broker-dealers. Commenters stated that requiring records to be

maintained at a one-person office or at an associated person's home

would be extremely burdensome and could interfere with a broker-

dealer's supervisory duties. By reproposing the definition of local

office to include an office with two or more associated persons, the

Commission has attempted to eliminate those situations in which a

broker-dealer has minimal presence at a particular location, such as

one associated person at a bank branch, while still providing

securities regulatory authorities with local access to office records

of a broker-dealer.

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\22\ Reproposed Rule 17a-3(g)(1).

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The Commission requests comment on whether, and if so, how many and

why, a higher number of associated persons would be appropriate for the

definition of local office. The Commission requests commenters to

provide, if applicable, information on the number of offices in each

state that would fall within the reproposed definition of a local

office, the number of offices that would fall within the definition

suggested by the commenter, and the total number of offices for that

broker-dealer firm. Commenters also should specify what percentage of

the firm's business is conducted at the local offices as defined under

the reproposed amendments and under any alternative definitions

suggested by the commenter.

2. Local Office Records

The reproposed amendments would require broker-dealers to make and

keep separately for each local office records including blotters,

broker and dealer order tickets, customer account records, customer

complaints, evidence of compliance with securities regulatory authority

rules, a list of state record depositories, names of persons capable of

explaining the records, and names of any principals responsible for

establishing policies and procedures, and records relating to the

associated persons at each local office including employment

agreements, identification numbers, compensation agreements, sales

records relating to associated person compensation, and chronological

sales records.23 Keeping these records regarding each local

office would assist securities regulators by enabling them to conduct

focused localized examinations of particular offices and identify

abusive activities that may be isolated to that office.

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\23\ Reproposed Rule 17a-3(f).

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3. Record Retention at Local Offices

The reproposed amendments would require broker-dealers to make

available at the respective local office certain records, including

blotters of the local office's activities, memoranda of brokerage

orders and dealer transactions, customer account records, customer

complaints, and associated person records (collectively ``Local Office

Records'').24 The Commission is now proposing that Local

Office Records be kept at the local office for the most recent one year

period. Requiring a year's worth of Local Office Records at the local

office should provide securities regulators with sufficient records to

conduct examinations of local offices while not imposing unnecessary

burdens on broker-dealers. After a year, broker-dealers would still be

required to keep Local Office Records at their headquarters office or

some other centralized location, subject to the accessibility

requirements of Rules 17a-4(a) and (b).

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\24\ Reproposed Rule 17a-4(k).

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The Commission is seeking comment on whether state securities

regulators should have authority to waive the requirement that a

broker-dealer keep Local Office Records at local offices within their

respective states. The Commission also seeks comment on whether the

reproposed record retention period of one year for local offices is

appropriate.

4. Alternative Means of Record Retention

The Commission recognizes that some broker-dealers have

recordkeeping systems that are more technologically advanced than

others. These systems should enable broker-dealers to provide

securities regulators with records at a local office in a timely manner

without actually keeping the records at a local office. Therefore, the

Commission is proposing an alternative means for satisfying the local

office recordkeeping requirements. A broker-dealer's capability to

produce printed copies of Local Office Records in a local office the

same day the request for the records is made, or within a reasonable

time under certain unusual circumstances, would satisfy the local

office recordkeeping requirements.25 By proposing an unusual

circumstance exception, the Commission is addressing situations in

which the broker-dealer has made a good faith effort to produce the

records, but meets an unexpected delay in the production of the

records. For example, the broker-dealer may experience a computer

communication failure that cannot be immediately rectified by a local

office. In contrast, the absence of a person authorized by the broker-

dealer to deliver the records would not be an acceptable reason for

delaying delivery of the requested records.

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\25\ Reproposed Rule 17a-4(k)(1).

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5. Promptly Furnishing Records at Local Offices

As proposed, the definition of the term ``promptly'' would have

specified that requested records must be produced immediately for

records located in the office where a request is made and within three

business days for records that are not located in the office. These

amendments were proposed so that securities regulators would have

prompt access to records while they were conducting examinations at

local offices. The reproposed amendments have been modified to reduce

the burden that the proposed amendments would have placed on broker-

dealers by allowing broker-dealers to use the alternative means of

record retention discussed above.26

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\26\ Id.

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[[Page 54410]]

G. State Record Depositories for Offices Not Meeting the Local Office

Definition

The reproposed rules modify the proposed definition of local office

to include offices with two or more associated persons. As to offices

with only one associated person, the Commission is reproposing that

those records may be stored at a state record depository. The state

record depository would have to be located in the same state in which

the office (or offices) not meeting the definition of local office is

located. Further, with respect to an associated person who works out of

more than one office, a state record depository would have to be

located in each state in which the associated person conducts business.

The Commission recognizes that this may place an additional burden on

some broker-dealers; however, the Commission believes that to support

examinations by state securities regulators, these associated person

records must be available in the state in which that person is active.

The Commission requests comment on whether, to what extent, and under

what circumstances a state should be permitted to waive the state

record depository requirement for broker-dealers conducting business in

its state.

H. Records Regarding Approval of Communications

The proposed amendments would have required a record be kept

indicating whether outgoing communications had been approved by a

principal. The reproposed amendments modify that proposal to require

that a broker-dealer retain any written approvals of outgoing

communications sent and any written procedures it uses for reviewing

outgoing communications. This change reflects the recent amendments to

SRO rules which permit member firms to establish reasonable procedures

for reviewing a registered representative's communications with the

public.27 The Commission also is proposing to add a

requirement that broker-dealers maintain a record of any written

procedures for reviewing marketing materials and a record listing each

principal of a broker-dealer responsible for establishing policies and

procedures to ensure compliance with applicable regulations of a

securities regulatory authority that require approval of a record by a

principal.28 These requirements are designed to allow easier

examination for sales practice abuses, such as unauthorized trading,

suitability, churning, and other misrepresentations.

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\27\ See Exchange Act Release No. 39510 (Dec. 31, 1997), 63 FR

1131 (Jan. 8, 1998) and Exchange Act Release No. 39511 (Dec. 31,

1997), 63 FR 1135 (Jan. 8, 1998).

\28\ Reproposed Rule 17a-4(b)(10).

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I. Audit and Examination Reports

The proposed amendments would have required broker-dealers to keep

for at least three years all audit or examination reports prepared by a

person other than the broker-dealer. Several commenters stated that

this requirement is not warranted because it might discourage self-

critical evaluations of a firm's business, particularly if the firm

would be required to share the report with regulators that may not have

authority to protect the confidentiality of the reports. In light of

this, the Commission is reproposing the requirement that each broker-

dealer keep for three years all reports requested or required by a

securities regulatory authority and any securities regulatory authority

examination reports.29 This requirement would help avoid

unnecessary duplication in examinations. The Commission requests

comment on whether there are any reasons why broker-dealers should not

be required to keep such reports (for example, confidentiality concerns

arising from particular state law requirements).

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\29\ Reproposed Rule 17a-4(e)(5).

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J. Technical Amendments

On February 5, 1997, the Commission amended Rule 17a-4 to allow

broker-dealers to employ, under certain conditions, electronic storage

media to maintain its records.30 The Commission is now

proposing technical amendments to that rule.31 The

Electronic Storage Media Release provided that a broker-dealer that

employs micrographic or electronic storage media must be ready at all

times to immediately provide a facsimile enlargement upon request by

the Commission or its representatives.32 It also provided

that for a broker-dealer that uses electronic storage media, a third

party download provider must file undertakings with that broker-

dealer's designated examining authority indicating that it will furnish

promptly to the Commission, its designees or representatives, the

information necessary to download information kept on a broker-dealer's

electronic storage media.33 Because SROs and state

securities regulators are neither representatives nor designees of the

Commission but, to the extent that they have jurisdiction over the

broker-dealer serviced by the third party download provider, are

organizations that should have access to facsimile enlargements and

download information, the Commission is proposing technical amendments

to provide them with access to these records.

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\30\ Exchange Act Release No. 38245 (Feb. 5, 1997), 62 FR 6469

(Feb. 12, 1997) (``Electronic Storage Media Release'').

\31\ Rule 17a-4(f).

\32\ See Rule 17a-4(f)(3)(i).

\33\ See Rule 17a-4(f)(3)(vii).

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IV. General Request for Comments

The Commission invites interested persons to submit written

comments on all the reproposed amendments. Also, the Commission

specifically requests comments concerning the definition of local

office; the one year record retention period for local office records;

and the retention and production of external audit, examination, and

consulting reports.

The Commission requests comment regarding whether there are

alternative books and records requirements that would facilitate

examination of local offices and review of sales and trading practices.

Are there any other records, in addition to compensation records, that

the Commission should require broker-dealers to retain that would show

sales incentives?

Is it necessary for Commission rules to also provide for state

regulator access to books and records? Are there other measures the

Commission could undertake to promote cooperation and coordination with

state securities regulators regarding examinations and enforcement

actions regarding broker-dealers? Are there alternatives to the local

office requirements that would similarly expedite examinations away

from a broker-dealer's home office?

With respect to the proposed requirement that broker-dealers be

able to demonstrate compliance with certain SRO and state securities

regulatory requirements, is there an alternative way for securities

regulators to obtain this information? Are there other types of records

that would contain information that securities regulators may use to

identify potential regulatory concerns?

V. Effects on Efficiency, Competition, and Capital Formation

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

adopting rules under the Exchange Act, to consider any impact on

competition and to not adopt a rule that would impose a burden on

competition not necessary or appropriate in furtherance of the

Act.34 Pursuant to Section 3(f) of the Exchange Act, when

the Commission

[[Page 54411]]

considers whether an action is necessary or appropriate in the public

interest, the Commission considers whether the action will promote

efficiency, competition, and capital formation, in addition to the

protection of investors. The Commission is considering the reproposed

amendments to Rules 17a-3 and 17a-4 in light of these standards, and

the Commission believes that any burden imposed by the reproposed

amendments should be justified by the enhanced investor protection

described above. In addition, by improving examination capabilities,

the reproposed amendments should improve investor confidence in broker-

dealer firms and help maintain fair and orderly markets. The

requirements would apply to all broker-dealers that conduct business

with the general public. Larger broker-dealers would have

correspondingly greater obligations under the amendments. Accordingly,

any burden on broker-dealer competition should be slight, especially in

light of the significant regulatory benefits and investor protection

purposes discussed above. The Commission solicits comment on any effect

on efficiency, competition, or capital formation the reproposed

amendments may have.

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\34\ See 15 U.S.C. 78w(a)(2).

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VI. Costs and Benefits of the Proposed Amendments and Their Effects

on Competition

To assist the Commission in its evaluation of the costs and

benefits that may result from the reproposed amendments to Rules 17a-3

and 17a-4, commenters are requested to provide information relating to

costs and benefits associated with any of the proposals herein.

The requirements of reproposed rules 17a-3 and 17a-4 are discussed

together rather than separately because the underlying purposes for

both making and keeping the reproposed records are so closely related.

However, because the Commission requests specific comment on the costs

and benefits, including specific estimates of hour and dollar burdens

that may result from these reproposed amendments, commenters may wish

to discuss each rule and the subparts of each rule individually.

A. Benefits

The reproposed amendments should result in increased efficiency and

effectiveness of broker-dealer examinations especially with respect to

local offices. The enhanced recordkeeping requirements would also

provide critical information necessary for securities regulatory

authorities to discover and take appropriate action for various

securities violations, particularly, sales practice violations.

Generally, the reproposed amendments would require additional

information in four main areas including (1) customer information, (2)

associated person information, (3) transaction information (i.e.,

purchases and sales), and (4) local office information. The reproposed

rules relating to additional customer information (i.e., the account

record) would provide a clear and relatively current record of customer

information, including a customer's financial profile and investment

objectives. This record would provide securities regulators with

information to enable them to determine whether transactions in

particular securities were suitable for a customer.

The reproposed amendments relating to associated person information

can be further broken down into two categories including compensation

records and complaint records organized according to associated person.

First, the compensation records would help provide securities

regulators with insight into why associated persons may have conducted

certain transactions. For example, the compensation records would allow

securities regulators to determine whether financial or other

incentives existed that may have led an associated person to engage in

excessive transactions. Second, the complaint records organized

according to registered representative would allow securities

regulators to determine whether an associated person has engaged or is

continuing to engage in certain securities violations such as sales

practice abuses.

The reproposed amendments relating to transactions would require

broker-dealers to include on order tickets, among other things, the

time the order was received, the identity of the associated person

responsible for the account, and the identity of any other person who

accepted or entered the order. First, the requirement that an order

ticket note the time the order was received would allow securities

regulators to determine whether the broker-dealer executed the

transaction in a timely manner and in compliance with applicable

regulations. Second, indicating on the order ticket the identity of the

associated person responsible for the account as well as the identity

of any other person who entered or accepted the order would provide

securities regulators with insight into a variety of abusive

activities. For example, securities regulators would be better able to

identify situations in which a person who was barred from the industry

was, nevertheless, continuing to associate with a broker-dealer by

entering orders under another person's name. Additionally, the records

could help reveal that a broker-dealer was engaging in boiler room

activities in situations in which numerous associated persons were

accepting and entering orders under one associated person's name.

With respect to local office information, the requirement that

certain records be kept for each local office would allow securities

regulators to conduct a focused localized exam of a particular office

and identify abusive activities that may be isolated to that office.

Further, requiring broker-dealers to store certain records at local

offices would allow securities regulators to conduct more effective and

thorough examinations because they would be able to conduct the

examinations on-site where they could review the pertinent records and

interview various employees regarding the contents of those records.

Additionally, making the records available at the local office is

important to reduce the potential for alteration or fabrication of

records when requested. Finally, requiring broker-dealers to maintain

or make available particular records at local offices would help

facilitate examinations by state securities regulators because the

records would be located within that regulator's jurisdiction.

B. Costs

Many of the records required under the reproposed amendments

already are required under SRO rules, thus, tempering the impact of the

reproposed amendments on broker-dealers. However, the Commission

recognizes that compliance with the reproposed rules may require

broker-dealers to make certain adjustments to their current systems and

methods of record creation and storage.

The Commission believes that the bulk of the additional costs of

the reproposed amendments would result from three areas: (1) the

requirement that account records be updated; (2) the requirement that

certain records regarding local offices be made; and (3) the

requirement that records be stored at or made available at local

offices or state record depositories.35 Accordingly, the

Commission has included certain provisions in the reproposed amendments

that should lessen the impact on broker-dealers. For example, rather

than storing hard copies of certain records, local offices may use a

[[Page 54412]]

system, which could range from ordinary E-Mail to a Local Area Network

system to an intranet system, capable of producing printed copies of

the records at the local office. The Commission believes that many

broker-dealers already have in place systems that are capable of

transmitting the information between offices immediately or on the same

business day. This provision should provide securities regulators with

timely access to records without requiring broker-dealers to actually

produce and store in hard copy format every record required under the

reproposed rules. The Commission seeks comment on alternative systems

or methods of storing records or providing local offices and state

record depositories with timely access to records.

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\35\ The Paperwork Reduction Act section of this release

contains additional information relating to costs.

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In some instances, the reproposed amendments provide that broker-

dealers may choose between alternative methods of recordkeeping. For

example, the reproposed amendments relating to the contents of an order

ticket would add the requirement that order tickets contain, among

other things, the identity of each associated person and any other

person who entered or accepted the order. However, if the broker-

dealer's system is incapable of receiving an entry for any other person

or if the alteration to the system would be costly, the broker-dealer

would not have to alter its system; rather, the broker-dealer may make

a separate record of the additional persons who enter or accept orders.

VII. Summary of Initial Regulatory Flexibility Analysis

In accordance with 5 U.S.C. 603, the Commission has prepared an

Initial Regulatory Flexibility Analysis (``IRFA'') concerning the

reproposed amendments. The IRFA notes that the purpose of the

reproposed amendments is to enhance the ability of securities

regulators to protect investors through more effective and efficient

examinations and enforcement proceedings. The Commission believes that

the reproposed amendments are necessary to ensure that registered

broker-dealers keep books and records that are sufficient to permit

securities regulators to conduct complete sales practice and

operational examinations. The IRFA further states that the reproposed

amendments would affect all broker-dealers, including the approximately

1,389 small broker-dealers, but notes that the requirements of the

reproposed amendments were designed to minimize additional burdens. It

also states that the reproposed amendments may require broker-dealers

to adjust their record making and keeping practices and to update

certain customer information records every 36 months. The IRFA states

that no federal securities laws duplicate, overlap, or conflict with

the reproposed amendments and that the Commission does not believe that

any less burdensome alternatives are available to accomplish the

objectives of the reproposed amendments.

The Commission encourages the submission of written comments with

respect to any aspect of the IRFA. If the reproposed amendments are

adopted, written comments will be considered in preparation of the

Final Regulatory Flexibility Analysis. Comments will be placed in the

same public file as that designated for the reproposed amendments. A

copy of the IRFA may be obtained by contacting Deana A. La Barbera,

Division of Market Regulation, Securities and Exchange Commission, 450

Fifth Street, N.W., Mail Stop 10-1, Washington, D.C. 20549, (202) 942-

0734.

VIII. Paperwork Reduction Act

Certain provisions of the reproposed amendments contain

``collection of information'' requirements within the meaning of the

Paperwork Reduction Act of 1995.36 The Commission has

submitted the reproposed amendments to the Office of Management and

Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5

CFR 1320.11 under the title ``Reproposed Books and Records

Amendments.''

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\36\ 44 U.S.C. 3501 et seq.

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A. Collection of Information Under Reproposed Books and Records

Amendments

As discussed previously in this release, the Reproposed Books and

Records Amendments would require registered broker-dealers to maintain

additional records with respect to purchase and sale documents,

customer information, associated person information, customer

complaints, and certain other matters.

B. Proposed Use of Information

The information collected pursuant to the Reproposed Books and

Records Amendments would be used by the Commission, self-regulatory

organizations, and other securities regulatory authorities for

examinations and enforcement proceedings regarding broker-dealers and

associated persons. No governmental agency would regularly receive any

of the information described above. Instead, the information would be

stored by the registered broker-dealer and made available to the

various securities regulatory authorities for examinations and

enforcement proceedings. To comply with the reproposed amendments that

require broker-dealers to update customer account records at least

every 36 months, broker-dealers would have to furnish their customers

with a copy of the account record. This requirement and the estimated

burden associated with it are discussed in detail in section D below.

C. Respondents

The Reproposed Books and Records Amendments would apply to all the

approximately 7,769 active broker-dealers 37 that are

registered with the Commission. Most of the provisions of the

Reproposed Books and Records Amendments would apply only to the

approximately 5,400 broker-dealers that conduct business with the

general public; this is because most of the provisions relate to a

broker-dealer's and its associated persons' dealings with customers

(e.g., the requirement that broker-dealers update customer account

records).

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\37\ Of approximately 8,500 broker-dealers registered with the

Commission, approximately 450 are not yet active because their

registration is pending SRO approval and approximately 300 are

inactive because they have ceased doing a securities business and

have filed a Form BDW with the Commission.

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D. Total Annual Reporting and Recordkeeping Burden

The hour burden of the Reproposed Books and Records Amendments

would vary widely because of differences in the levels of activities of

the respondents and because of differences in the current recordkeeping

systems of the respondents. Therefore, the estimates in this section

are based on averages among the various types and sizes of broker-

dealer firms. Most of the requirements of the Reproposed Books and

Records Amendments involve collections of information that typical

broker-dealers already maintain under customary and usual business

practices or in compliance with SRO rules.

The reproposed amendments modify Rule 17a-3 by, among other things,

requiring broker-dealers to update customer account records at least

every 36 months. Broker-dealers currently maintain approximately

60,000,000 customer accounts. Because the account records must be

updated at least once every 36 months, the Commission estimates that,

on average, the account records of one-third of the total accounts

(i.e. 20,000,000) would have to be updated each year. To comply with

this

[[Page 54413]]

requirement, broker-dealers would have to furnish customers with the

existing account record and request that the customer make any

necessary changes. However, the Commission believes that not every

account record will be changed in response to the broker-dealer's

request for updated information because the account record may still be

current or the customer may elect not to respond. The Commission

estimates that approximately 10% of the requests for updated

information will result in changes to the record resulting in 2,000,000

(10% of \1/3\ of total customer accounts) updated account records each

year. The Commission estimates that it will take, on average, 10

seconds to furnish the account record to each customer. The Commission

further estimates that it will take, on average, five minutes for a

broker-dealer to update each account record. This estimate takes into

account the amount of time it would take to receive the returned data

and input any changes into the account record. Additionally, this time

estimate takes into account that certain SRO rules already require

broker-dealers to maintain current information about their customers

and that broker-dealers maintain current account record information in

the ordinary course of business.

Therefore, the Commission estimates that the requirement that

broker-dealers update account records would require approximately

222,223 hours each year; this is derived from 55,556 hours to furnish

the account records to customers (20,000,000 account records x 10

seconds / 60 seconds / 60 minutes) plus 166,667 hours each year to

receive and input the updated information (2,000,000 account records

x 5 minutes / 60 minutes)38

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\38\ The Commission staff estimates that the approximate

administrative and labor costs to broker-dealers to comply with this

requirement would be $25 per hour (based on an annual salary of

$52,000) resulting in a total annual cost of $5,555,575 (based on

$25 per hour multiplied by 222,223 burden hours). This estimate does

not include any systems costs.

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In addition to the account record updating requirement, the

Reproposed Books and Records Rules would require broker-dealers to keep

certain records regarding their associated persons, including

agreements pertaining to the associated person's relationship with the

broker-dealer, compensation arrangements, identification numbers, the

office at which each associated person's records are

stored,39 each associated person's compensation for each

transaction,40 and a chronological sales

record.41 With the exception of the compensation record and

chronological sales record, the records are the type of records that

would be updated infrequently. Additionally, the Commission believes

that all these records are the type of records that broker-dealers

would keep in the ordinary course of business. Therefore, the

Commission estimates that, on average, these records would require a

broker-dealer to spend approximately 30 minutes each year to ensure

that it is in compliance with the reproposed amendments.

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\39\ Reproposed Rule 17a-3(a)(12).

\40\ Reproposed Rule 17a-3(a)(18).

\41\ Reproposed Rule 17a-3(a)(20).

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The reproposed amendments also would require broker-dealers to make

records which indicate that they have complied with any applicable

regulations of securities regulatory authorities,42 and

which list persons who can explain the information in the broker-

dealer's records,43 each principal responsible for

establishing compliance policies and procedures,44 and each

office designated as a state record depository.45 The

Commission believes that the information required under each of these

rules would be readily available to broker-dealers and is the type of

information that would change infrequently. Therefore, the Commission

estimates that, on average, a broker-dealer would spend approximately

10 minutes each year to ensure that it is in compliance with these

requirements.

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\42\ Reproposed Rule 17a-3(a)(19).

\43\ Reproposed Rule 17a-3(a)(21).

\44\ Reproposed Rule 17a-3(a)(22).

\45\ Reproposed Rule 17a-3(a)(23).

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The reproposed amendments also would require that broker-dealers

keep a record of customer complaints.46 Broker-dealers

already are required to keep this information under existing SRO rules;

however, under the reproposed rules, the record must be made available

at the local office or state record depository. The Commission believes

that because broker-dealers already maintain these records, any

additional burden resulting from this requirement would be nominal.

Therefore, the Commission estimates that, on average, the burden would

be 20 minutes per broker-dealer each year to ensure that it is in

compliance with this rule.

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\46\ Reproposed Rule 17a-3(a)(17).

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The reproposed amendments relating to order tickets would require

that broker-dealers note the time the order was received and the name

of any person other than the associated person responsible for the

account who accepted or executed the order.47 The Commission

believes that, in the ordinary course of business, most broker-dealers

already note on the order ticket the time the order was received;

therefore, this requirement would not impose an additional burden on

broker-dealers.

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\47\ Reproposed Rules 17a-3(a)(6) and (a)(7).

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The degree of the burden imposed by the requirement that any

additional person be noted on the order ticket depends largely upon the

business practices of the individual firms and their current

recordkeeping systems; therefore, it is difficult for the Commission to

provide an accurate estimate of the burden associated with this

requirement. The Commission believes, however, that any additional

burden would be nominal because the requirement may be satisfied by a

minor notation on the order ticket or on a separate record.

In total, the Commission estimates that compliance with the

Reproposed Books and Records Rules for Rule 17a-3 would require an

additional 229,992 hours per year ((222,223 hours (annualized account

record updating) + 7,769 hours 48 (one hour per broker-

dealer each year for the balance of the additional rules)). Therefore,

the current OMB inventory of 1,941,062 hours for Rule 17a-3 would

increase by 229,992 hours to 2,171,054 hours.

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\48\ The Commission staff estimates that the approximate cost to

broker-dealers to comply with this requirement would be $48.08 per

hour (based on an annual salary of $100,000) including the value of

professional staff compensation and related overhead resulting in a

total annual cost of $373,534 (based on $48.08 per hour multiplied

by 7,769 burden hours). This estimate does not include any systems

costs.

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The Reproposed Books and Records Rules would modify Rule 17a-4 by

requiring broker-dealers to maintain additional books and records,

including materials used by a broker-dealer to offer or sell

securities, copies of reports produced to review activity in customer

accounts, and a record listing all persons who are qualified to explain

a broker-dealer's books and records. The reproposed amendments to Rule

17a-4 also would require broker-dealers to make available certain

records at the local offices or state record depositories. The

reproposed amendments provide that broker-dealers may retain the

records in a system capable of producing the records upon request,

which should minimize additional record retention burdens on broker-

dealers. Also, as discussed above, most of the additional records

already are maintained by the broker-dealers; therefore, the majority

of the additional burden would result from the requirement that broker-

dealers retain

[[Page 54414]]

records at local offices or state record depositories.

Based on the information above, the Commission estimates that, on

average, each broker-dealer would spend one business day each year to

ensure that it is in compliance with the reproposed amendments to Rule

17a-4 and to ensure that the records are available at local offices and

state record depositories. Therefore, the current OMB inventory for

Rule 17a-4 of 2,127,125 hours would be increased by 62,152 hours (7,769

active broker-dealers x 8 hours) resulting in a total of 2,189,277

hours.49

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\49\ The Commission staff estimates that the approximate

professional labor costs to the broker-dealer industry to comply

with this requirement would be $48.08 per hour (based on an annual

salary of $100,000) resulting annual cost of $2,988,268 (based on

$48.08 per hour multiplied by 62,152 burden hours). This estimate

does not include any systems costs.

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E. General Information About the Collection of Information

The collection of information under the Reproposed Books and

Records Amendments would be mandatory. The information collected

pursuant to Rules 17a-3(a)(17), (21), (22), and (23) would be retained

for six years. The information collected pursuant to Rules 17a-

3(a)(18), (19), and (20), 17a-4(b) (4), (7), (10), and (11), and 17a-

4(e)(5) would be retained for three years. The information collected

pursuant to Rule 17a-3(a)(16) would be retained for six years after the

closing of the related customer's account. The information collected

pursuant to Rule 17a-4(d) would be retained for the life of the

enterprise or any successor enterprise. The information collected

pursuant to Rule 17a-3(a)(20) would be retained for three years. The

information collected pursuant to Rule 17a-4(e)(6) would be retained

for three years after the date of the termination of use of the

information. In general, the information collected pursuant to the

Reproposed Books and Records Amendments would be held by the

respondent. The Commission, self-regulatory organizations, and other

securities regulatory authorities would only gain possession of the

information upon request. Any information received by the Commission

pursuant to the Reproposed Books and Records Amendments would be kept

confidential, subject to the provisions of the Freedom of Information

Act, 5 U.S.C. 552.

F. Request for Comment

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits

comments to:

(i) Evaluate whether the proposed collection of information is

necessary for the proposed performance of the functions of the

Commission, including whether the information shall have practical

utility;

(ii) Evaluate the accuracy of the Commission's estimate of the

burden of the proposed collection of information;

(iii) Enhance the quality, utility, and clarity of the information

to be collected; and

(iv) minimize the burden of the collection of information on those

required to respond, including through the use of automated collection

techniques or other forms of information technology.

Persons desiring to submit comments on the collection of

information requirements should direct them to the Office of Management

and Budget, Attention: Desk Officer for the Securities and Exchange

Commission, Office of Information and Regulatory Affairs, Washington,

D.C. 20503, and should also send a copy of their comments to Jonathan

G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth

Street, N.W., Mail Stop 6-2, Washington, D.C. 20549, and refer to File

No. S7-26-98. OMB is required to make a decision concerning the

collections of information between 30 and 60 days after publication of

this release in the Federal Register, therefore, comments to OMB are

best assured of having full effect if OMB receives them within 30 days

of this publication.

IX. Statutory Analysis

The amendments are proposed pursuant to the authority conferred on

the Commission by the Exchange Act, including Sections 17(a) and 23(a).

List of Subjects in 17 CFR Part 240

Brokers, Reporting and recordkeeping requirements, Securities.

For the reasons set forth in the preamble, Title 17 Chapter II of

the Code of Federal Regulation is proposed to be amended as follows:

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

1934

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

follows:

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

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

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

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

80b-11, unless otherwise noted.

* * * * *

2. Section 240.17a-3 is amended by revising paragraphs (a)(6),

(a)(7), and (a)(12)(ii), and adding paragraphs (a)(12)(iii),

(a)(12)(iv), (a)(12)(v), (a)(16), (a)(17), (a)(18), (a)(19), (a)(20),

(a)(21), (a)(22), (a)(23), (f) and (g) to read as follows:

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

and dealers.

(a) * * *

(6) A memorandum of each brokerage order, and of any other

instruction, given or received for the purchase or sale of securities,

whether executed or unexecuted. The memorandum shall show the terms and

conditions of the order or instructions and of any modification or

cancellation thereof; the account for which entered; the time the order

was received; the time of entry; the price at which executed; the time

of execution or cancellation, to the extent feasible; and, except as

otherwise provided in this paragraph, the identity of each associated

person responsible for the account and any other person who entered or

accepted the order on behalf of the customer. If a person other than

the associated person responsible for the account entered the order

into an electronic system that generates the required memorandum and

the system is not capable of receiving an entry of the identity of any

person other than the responsible associated person, the member, broker

or dealer shall create a separate record which identifies each other

person upon request. An order entered pursuant to the exercise of

discretionary power by the member, broker or dealer, or associated

person or other employee thereof, shall be so designated. The term

instruction shall include instructions between partners and employees

of a member, broker or dealer. The term time of entry shall mean the

time when the member, broker or dealer transmits the order or

instruction for execution.

(7) A memorandum of each purchase and sale for the account of the

member, broker, or dealer showing the price and, to the extent

feasible, the time of execution; and, in addition, where the purchase

or sale is with a customer other than a broker or dealer, a memorandum

of each order received showing the terms and conditions of the order or

instructions and of any modification or cancellation thereof; the

account for which entered; the time the order was received; the time of

entry; the price at which executed; the time of execution or

cancellation, to the extent feasible; and, except as otherwise provided

in this paragraph, the identity of each associated person responsible

for the account and any other person

[[Page 54415]]

who entered or accepted the order on behalf of the customer. If a

person other than the associated person responsible for the account

entered the order into an electronic system that generates the required

memorandum and the system is not capable of receiving an entry of the

identity of any person other than the responsible associated person,

the member, broker or dealer shall create a separate record which

identifies each other person upon request. Orders entered pursuant to

the exercise of discretionary power by the member, broker or dealer, or

associated person or other employee thereof, shall be so designated.

The term instruction shall include instructions between partners and

employees of a member, broker or dealer. The term time of entry shall

mean the time when the member, broker or dealer transmits the order or

instruction for execution.

* * * * *

(12) * * *

(ii) A record of all agreements pertaining to the relationship

between each associated person and the member, broker or dealer.

(iii) A record containing a summary of each associated person's

compensation arrangement or plan with the member, broker or dealer,

including commission schedules.

(iv) A record identifying any internal identification number

assigned to each associated person by a member, broker or dealer and

the Central Registration Depository number, if any, assigned to each

associated person.

(v) A record listing each associated person on behalf of the

member, broker or dealer including the office of the member, broker or

dealer out of which the associated person works and the local office or

state record depository the records pertaining to that associated

person are preserved pursuant to Sec. 240.17a-4.

* * * * *

(16) For each account that has a natural person as the beneficial

owner (including a joint account with one or more natural persons as

the beneficial owners):

(i)(A) An account record containing the customer's name, Social

Security number (or other tax identification number), address and

telephone number, date of birth, marital status, number of dependents,

employment status (including occupation and whether the customer is an

associated person of a member, broker or dealer), annual income and net

worth (excluding value of primary residence), and investment objectives

or risk tolerance. In the case of a joint account, the information

shall be included for each individual on the joint account. The account

record shall indicate that it has been approved by the associated

person responsible for the account and by a principal of the member,

broker or dealer. If an account is a discretionary account, the record

must contain the dated signature of each customer granting the

discretionary authority and the dated signature of each person to whom

discretionary authority was granted.

(B)(1) Every member, broker or dealer shall furnish to each

customer within 30 days of opening the account and thereafter at least

once every 36 months (at intervals no greater than 36 months) a copy of

the customer's account record or an alternate document with all

information required by paragraph (a)(16)(i)(A) of this section. For an

account existing on [the effective date of the final rule], the initial

36 month period shall begin on [the effective date of the final rule].

For an account opened after [the effective date of the final rule] the

initial 36 month period shall begin on the day the initial account

record is sent to the customer

(2) For each account record of a customer updated to reflect a

change in the name, address, or investment objectives of the customer,

a member, broker or dealer shall furnish to that customer, no later

than 30 calendar days after the date it received notice of the change

of name, address, or investment objectives, a copy of that customer's

account record or an alternate document containing all required

information set forth on the account record. If the account is updated

to reflect a change of address, the member, broker or dealer shall

furnish the account record to the new address and a notice of the

change of address to the old address.

(3) The account record or alternate document furnished to the

customer shall include or be accompanied by a prominent statement

advising the customer that, if any information on the account record or

alternate document is incorrect, the customer should mark any

corrections and return the account record or alternate document to the

member, broker or dealer. Within 30 calendar days of receipt from a

customer any corrections or changes to the contents of an account

record or alternate document, a member, broker or dealer shall furnish

a copy of the revised account record or alternate document to the

customer and to the associated person who is responsible for that

customer's account.

(C) The neglect, refusal, or inability of a customer to provide or

update any required information for the customer's account record shall

excuse the member, broker or dealer from obtaining the required

information. The member, broker or dealer shall make a record of its

failure to obtain the required information when opening the account.

The record shall contain an explanation of the neglect, refusal, or

inability of the customer to provide the required information and the

name of the person that recorded the neglect, refusal, or inability on

behalf of the member, broker or dealer.

(ii) A record, which need not be separate from the account record,

for each account opened or updated after [the effective date of the

final rule] indicating compliance with any applicable regulations of a

securities regulatory authority that require certain information about

a customer be obtained when opening or updating a customer account.

This record shall include the date the member, broker or dealer

fulfilled its obligations regarding the opening or updating of the

customer account under any applicable regulations of a securities

regulatory authority.

(iii) A record indicating that the customer was furnished with a

copy of any written agreement pertaining to the customer's account. If

a member, broker or dealer furnishes to a customer a copy of any

written agreement that does not include the customer's signature, upon

request, the customer shall be furnished with a signed copy of the

written agreement pertaining to the customer's account.

(17)(i) A record as to each associated person of each written

customer complaint received by the member, broker or dealer concerning

that associated person. The record shall include, at least, the

complainant's name, address, and account number; the date the complaint

was received; the name of any associated person identified in the

complaint; a description of the nature of the complaint; and the

disposition of the complaint. Instead of the record, a member, broker

or dealer may maintain a copy of the original complaint along with a

record of the disposition of the complaint.

(ii) A record indicating that each customer of the member, broker

or dealer has been provided with a notice containing the address and

telephone number of the department of the member, broker or dealer to

which any complaints may be directed.

(18) A record as to each associated person listing all purchases

and sales of securities for which the associated person was

compensated, the amount of compensation (whether monetary or

[[Page 54416]]

nonmonetary), and the specific security involved. To the extent that

compensation is based on factors other than remuneration per trade,

such as a total production credit or bonus system, the member, broker

or dealer must be able to demonstrate and to document upon request the

method by which the compensation is determined. In lieu of making these

records, a member, broker or dealer may maintain, through electronic

means, the data necessary to promptly create the records upon request.

(19) A record indicating compliance with any applicable regulations

of a securities regulatory authority which require that materials used

by a member, broker or dealer or any associated person to offer or sell

any security have been approved by a principal. These materials may

include advertisements, marketing materials, sales scripts, and other

paper or electronic material, such as audio or video tapes. This

provision does not apply to those materials used only for internal

purposes.

(20) A record as to each associated person listing chronologically

all customer purchase or sale transactions for which the associated

person entered the orders or was primarily responsible for the

customer's account.

(21) A record listing all persons who, without delay, can explain

the information contained in the records (or type of records) required

pursuant to this section and those records required to be retained

pursuant to Sec. 240.17a-4.

(22) A record listing each principal of a member, broker or dealer

responsible for establishing policies and procedures that are

reasonably designed to ensure compliance with any applicable

regulations of a securities regulatory authority that require

acceptance or approval of a record by a principal.

(23) A record listing each office of a member, broker or dealer

indicating whether the office is a local office or has been designated

as a state record depository, and listing each associated person

working out of or storing records at that office.

* * * * *

(f) Every member, broker or dealer shall make and keep current,

separately for each office, the books and records described in

paragraphs (a)(1), (a)(6), (a)(7), (a)(12), (a)(16), (a)(17), (a)(18),

(a)(19), (a)(20), (a)(21), (a)(22) and (a)(23) of this section

reflecting the activities of that office. This requirement may be

satisfied by demonstrating that the data is maintained in a system

which is capable of promptly generating the records for each office

upon request.

(g) When used in this section:

(1) The term local office means any location where two or more

associated persons regularly conduct the business of handling funds or

securities or effecting any transactions in, or inducing or attempting

to induce the purchase or sale of any security, or otherwise soliciting

transactions or accounts for a member, broker or dealer.

(2) The term principal means any individual registered with the

National Association of Securities Dealers Regulation, Inc. as a

principal or branch manager of a member, broker or dealer.

(3) The term securities regulatory authority means the Commission,

any state securities regulatory agency authorized by law to examine

members, brokers or dealers subject to its jurisdiction, or any self-

regulatory organization.

3. Section 240.17a-4 is amended by revising paragraph (a), the

introductory text of paragraph (b), paragraphs (b)(1), (b)(4), and

(b)(7), the introductory text of paragraph (b)(8), and paragraphs (d),

and (j), and adding paragraphs (b)(10), (b)(11), (e)(5), (e)(6), (k)

and (l) to read as follows:

Sec. 240.17a-4 Records to be preserved by certain exchange members,

brokers and dealers.

(a) Every member, broker and dealer subject to Sec. 240.17a-3 shall

preserve for a period of not less than six years (the first two years

in an easily accessible place, subject to the provisions set forth in

paragraph (k) of this section) all records required to be made pursuant

to Sec. 240.17a-3(a) (1), (2), (3), (5), (16), (17), (21), (22) and

(23).

(b) Every member, broker and dealer subject to Sec. 240.17a-3 shall

preserve for a period of not less than three years (the first two years

in an easily accessible place, subject to the provisions set forth in

paragraph (k) of this section):

(1) All records required to be made pursuant to Sec. 240.17a-3(a)

(4), (6), (7), (8), (9), (10), (18), (19) and (20).

* * * * *

(4) Originals of all communications received and copies of all

communications sent by the member, broker or dealer (including inter-

office memoranda and communications) relating to its business as such.

The member, broker or dealer shall also retain any written approvals of

communications sent and any written procedures it uses for reviewing

the communications received or sent by the member, broker or dealer

(including inter-office memoranda and communications) relating to its

business as such.

* * * * *

(7) All written agreements (or copies thereof) entered into by the

member, broker or dealer relating to its business as such, including

agreements with respect to any account.

(8) Records which contain the following information in support of

amounts included in the report prepared as of the audit date on Form X-

17A-5 (Sec. 249.617 of this chapter) Part II or Part IIA and in annual

audited financial statements required by Sec. 240.17a-5(d):

* * * * *

(10) All materials used by the member, broker or dealer or any

associated person, to offer or sell any security, even if intended only

for internal use. These materials include advertisements, marketing

materials, sales scripts, and other paper or electronic materials, such

as audio and video recordings. The member, broker or dealer shall also

retain any written procedures for reviewing these materials.

(11) Copies of reports produced to review unusual activity in

customer accounts. These reports include, but are not limited to,

reports that identify exceptional numerical occurrences, such as

frequent trading in customer accounts, unusually high commissions, or

an unusually high number of trade corrections or cancelled

transactions. In lieu of retaining copies of the reports, a member,

broker or dealer may maintain, by electronic means, the data necessary

to promptly create the reports upon request.

* * * * *

(d) Every member, broker and dealer subject to Sec. 240.17a-3 shall

preserve during the life of the enterprise and of any successor

enterprise all Forms BD (Sec. 249.501 of this chapter), all Forms BDW

(Sec. 249.501a of this chapter), all amendments to the Forms, all

licenses or other documentation showing the member's, broker's or

dealer's registration with state securities jurisdictions and self-

regulatory organizations, and all partnership articles or, in the case

of a corporation, all articles of incorporation or charter, minute

books and stock certificate books.

(e) * * *

(5) All reports requested or required by a securities regulatory

authority and any securities regulatory examination reports until at

least three years after the date of the report.

(6) All compliance, supervisory, and procedures manuals describing

the policies and practices of the member, broker or dealer with respect

to operations, compliance with all

[[Page 54417]]

applicable securities laws and regulations, and supervision of the

activities of each natural person associated with the member, broker or

dealer until at least three years after the termination of the use of

each manual.

* * * * *

(j) Every member, broker or dealer subject to this section shall

furnish promptly to a representative of the Commission legible, true,

and complete copies of those records of the member, broker or dealer,

that are required to be preserved under this section, or any other

records of the member, broker or dealer subject to examination under

Section 17(b) of the Act (15 U.S.C. 78q(b)) that are requested by the

representative of the Commission.

(k) Records required to be preserved by the provisions of this

section must be maintained at the headquarters office or other

centralized location of a member, broker or dealer. In addition,

records required to be maintained by Sec. 240.17a-3(a)(1), (a)(6),

(a)(7), (a)(12), (a)(16), (a)(17), (a)(18), (a)(19), (a)(20), (a)(21),

and (a)(22) and paragraphs (b)(4) and (e)(6) of this section which:

(1) Relate to a local office shall also be maintained at the local

office as follows:

(i) The most recent one year period of the records pertaining to a

local office shall be maintained at the local office of a member,

broker or dealer; or

(ii) In lieu of maintaining records at the local office, a member,

broker or dealer may comply with the local office record maintenance

requirements of this section by having the capability of producing

printed copies of the records at the local office during the same

business day as the request for the records is made or, if unusual

circumstances prevent the production of printed copies of the records

within the same business day, with the permission of the securities

regulator making the request, the records shall be made available

within a reasonable time. This capability shall not be deemed to

supersede paragraph (f) of this section.

(2) Relate to an office of a member, broker or dealer that does not

meet the definition of local office under Sec. 240.17a-3(g)(1), or

relate to an associated person who works out of multiple offices of a

member, broker or dealer, must be either maintained at the office, or

aggregated with the records of one or more other such offices or

associated persons at a state record depository designated by the

member, broker or dealer if the following requirements are met:

(i) The state record depository, which may be another office of the

member, broker or dealer, is located within the same state as the

office that does not meet the definition of local office, and with

respect to maintaining records for an associated person who works out

of multiple offices, the state record depository is located in each

state in which the associated person conducts its business; and

(ii) The records stored in the state record depository can be

easily identified and accessed for each office that does not meet the

definition of local office or for each associated person to the same

extent as if each such office or associated person kept separate

records in compliance with the local office recordkeeping requirements

of this section.

(l) When used in this section:

(1) The term local office shall have the meaning set forth in

Sec. 240.17a-3(g)(1).

(2) The term principal shall have the meaning set forth in

Sec. 240.17a-3(g)(2).

(3) The term securities regulatory authority shall have the meaning

set forth in Sec. 240.17a-3(g)(3).

Sec. 240.17a-4 [Amended]

4. In Sec. 240.17a-4, paragraph (f)(3)(ii) is amended by removing

the phrase ``the Commission or its representatives'' and in its place

adding ``the staffs of the Commission, any self-regulatory organization

of which it is a member, or any state securities regulator having

jurisdiction over the member, broker or dealer''.

5. In Sec. 240.17a-4, paragraph (f)(3)(vii) is amended by:

a. Removing the phrase ``the U.S. Securities and Exchange

Commission (``Commission''), its designees or representatives,'' and in

its place adding ``the U.S. Securities and Exchange Commission

(``Commission''), its designees or representatives, any self-regulatory

organization of which it is a member, or any state securities regulator

having jurisdiction over the member, broker or dealer,'';

b. Removing the phrase ``the Commission's or designee's staff'' and

in its place adding ``the staffs of the Commission, any self-regulatory

organization of which it is a member, or any state securities regulator

having jurisdiction over the member, broker or dealer'';

c. Removing each place it appears the phrase ``the Commission's

staff or its designee'' and in its place adding ``the staffs of the

Commission, any self-regulatory organization of which it is a member,

or any state securities regulator having jurisdiction over the member,

broker or dealer''.

Dated: October 2, 1998.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-27120 Filed 10-8-98; 8:45 am]

BILLING CODE 8010-01-P