Recordkeeping

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

Recordkeeping

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rules.

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SUMMARY: The Commodity Futures Trading Commission is adopting

amendments to the recordkeeping obligations established in Regulation

1.31. Specifically, the amendments will allow recordkeepers to store

most categories of required records on either micrographic or

electronic storage media for the full five-year maintenance period,

thereby harmonizing procedures for those firms regulated by both the

Commission and the Securities and Exchange Commission. Recordkeepers

will have the flexibility necessary to maximize the cost reduction and

time savings available from improved storage technology while

continuing to provide Commission auditors and investigators with timely

access to a reliable system of records.

EFFECTIVE DATE: June 28, 1999.

FOR FURTHER INFORMATION CONTACT: Edson G. Case, Counsel, or Lurie

Plessala Duperier, Special Counsel, Division of Trading and Markets,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155

21st. Street, NW, Washington, DC 20581. Telephone (202) 418-5430.

SUPPLEMENTARY INFORMATION:

I. Introduction

On June 5, 1998, the Commodity Futures Trading Commission

(``Commission'' or ``CFTC'') published a Federal Register Notice

proposing several amendments to the recordkeeping requirements of

Commission Regulation 1.31 (the ``Proposal'')\1\ In light of the

significant number of Commission registrants that are subject to the

recordkeeping requirements of the Securities and Exchange Commission

(``SEC''), the Proposal included many provisions similar to those

adopted by the SEC in 1997.\2\ The Proposal's overall design reflected

the Commission's dual goals of ``maximiz[ing] the cost-reduction and

time-savings arising from technological developments in the area of

electronic storage media'' and maintaining the type of safeguards that

``ensure the reliability of the recordkeeping process.'' \3\ The

comment period on the Proposal originally was due to expire on August

4, 1998. Upon request from the Futures Industry Association (``FIA''),

the Commission extended the deadline to August 18, 1998, to encourage

comment by interested persons.

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\1\ 63 FR 30668 (June 5, 1998).

\2\ 62 FR 6469 (Feb. 12, 1997). The SEC's rulemaking involved

reporting requirements for brokers or dealers under the Securities

Exchange Act of 1934. The Commission has relied on these rules in

addressing recordkeeping issues on prior occasions. See, e.g., 62 FR

39104 (July 22, 1997) (interpreting Commission requirements

affecting the use of electronic media by commodity pool operators

(``CPOs'') and commodity trading advisors (``CTAs'') and amending

Part 4 of the Commission's Rules in light of the interpretation); 62

FR 31507 (June 10, 1997) (issuing guidance regarding a futures

commission merchant's (``FCM's'') electronic delivery of

confirmation, purchase-and-sale, and monthly statements to customers

and the related recordkeeping requirements); 62 FR 7675 (February

20, 1997) (permitting the use of electronic records of customer

orders generated by an electronic order-routing system).

\3\ 63 FR at 30668.

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The commission is publishing final rules that respond to comments

expressed by industry participants and that track closely the SEC's

recordkeeping requirements. While the final rules are similar to the

Proposal in most respects, the Commission intends to modify certain

staff practices in light of the comments received. The final rules and

modifications to staff practices will provide recordkeepers with

opportunities to reduce costs and improve both the efficiency and

security of their recordkeeping systems by initiating a transition to

electronic storage of Commission-required records.

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The Commission recognizes the important role improved technology

can play in the continued development of the futures industry.

Minimizing unnecessary regulatory obstacles to the adopted of improved

technology is a goal of the industry members, customers, and the

Commission. Indeed, the pace of technological changes will require the

Commission continually to review the standards articulated in this rule

to ensure that the recordkeeping requirements reflect to the extent

possible the reality of established technological innovation. The

Commission therefore welcomes consultation with industry participants

and specific proposals regarding how the regulations might be amended

in the future to permit the futures industry to use available

technology and to respond to the Commission's legitimate need to have

access to complete and accurate records when necessary.

II. Nature of the Proposal

A. Current Rule 1.31

Commission Regulation 1.31 sets forth certain recordkeeping

requirements imposed by the CEA and Commission regulations. Subsection

(a) describes the general rule. It mandates that all records required

to be kept by the Act or Commission regulations (``required records'')

be maintained for five years and be kept ``readily accessible'' during

the first two years. It also defines the inspection and production

rights of representatives of the Commission and the Department of

Justice.\4\

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\4\ For example, Regulation 1.31(a) provides that all required

records shall be open to inspection by such representatives. It also

requires recordkeepers to provide copies of originals of any

required record ``promptly,'' upon request.

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Subsections (b) and (c) establish alternative requirements for

required records that are stored as reproductions. Recordkeepers that

fulfill the conditions for alternative treatment may dispose of

original required records. Eligibility for alternative treatment is

limited to particular classes of records that are reproduced on

microfilm, microfiche, or optical disk. Computer and machine generated

records are immediately eligible for reproduction and storage on one of

the alternative media. Most other required records become eligible

after two years of storage. Trading cards and written customer orders

are ineligible; originals must be maintained for the full five-year

period. Subsection (c) describes the special inspection and production

conditions applicable to recordkeepers that choose to store

reproductions rather than original required records.\5\

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\5\ For example, persons maintaining reproductions must maintain

indexes of the records and have facilities that permit

representatives of the Commission and the Department of Justice to

review and obtain hard copies of the records immediately. For

records stored on optical disk, Regulation 1.31(c)(1)(iii) also

mandates that a copy of each record be immediately provided ``on

Commission compatible machine-readable media as defined in

[Commission Regulation] 15.00(1) * * *.''

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B. Proposed Rules

The Proposal would eliminate the current requirement that the

original of most required records be maintained for two years.\6\

Immediate storage of reproductions maintained on micrographic or

electronic storage media will enable recordkeepers to lower storage

costs significantly by discarding original records following the

successful storage of a reproduction. Moreover, the Proposal gave

recordkeepers increased flexibility in selecting the advanced

technology best suited to their business requirements by substituting

the less restrictive category ``electronic storage media'' for

``optical disk'' in describing the storage media recordkeepers could

employ.\7\ As a result, recordkeepers may now take advantage of

electronic storage technologies such as digital tape.\8\

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\6\ The Proposal retained the current regulation's requirement

that original trading cards and written customers orders be retained

for the full five-year period. Proposal at 30669-70. It also sought

to clarify the type of records ineligible for micrographic or

electronic storage by referring to ``written orders'' rather than

``written customer orders'' and to ``documents on which trade

information is originally recorded in writing'' rather than

``trading cards.'' The documents included in the Proposal's revised

category are among the ``original source documents'' that Commission

Regulation 1.35(a) requires to be retained and produced. Proposal at

30671.

\7\ The current rule's definition of acceptable optical storage

systems, for example, requires that the system write files in ASCII

or EBCDIC format and use removable disks. The Proposal, however,

permitted recordkeepers to employ any digital storage medium or

system that meets four generic requirements: (1) preserves records

exclusively in a non-rewritable, non-erasable format; (2) verifies

automatically the quality and accuracy of the recording process; (3)

serializes the units of storage media and creates a time-date

whenever information is placed on the storage media; and (4) permits

the immediate downloading of indexes and records maintained on the

storage media to any of the media permitted by the regulation

(paper, micrographic media or electronic media).

\8\ The Proposal did not require Commission approval of plans to

convert to a system that maintains records on electronic storage

media. Recordkeepers, however, must submit a representation to the

Commission that the selected electronic storage system meets the

four generic requirements.

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In addition, consistent with both the SEC's approach and current

Commission requirements, the Proposal set forth several conditions on

recordkeepers who choose to meet their obligations by retaining

reproductions rather than original records--including safeguards to

endure timely access to the reproductions and the Commission's ability

to maintain its access to required records despite catastrophic

events.\9\

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\9\ Recordkeepers were required to: (1) maintain facilities that

allow immediate production of both an easily readable image of the

stored records and an easily readable hard-copy; (2) maintain an

index of stored documents that permits immediate location of a

particular document; and (3) waive any privilege, claim of

confidentiality or other objection to disclosure of non-Commission-

required documents stored on the same individual medium as

Commission-required documents. In regard to catastrophic events, the

Proposal noted that the Commission had lost access to required

records due to a fire at a Chicago storage warehouse in 1996.

Proposal at 30669 n.12. To avoid this problem in the future, the

Proposal required recordkeepers to maintain a duplicate of both

stored records and required indexes at a separate location.

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The Proposal articulated additional conditions on recordkeepers

that choose to meet their obligations by retaining reproductions on

electronic storage media rather than micrographic storage media. First,

to ensure that there was an effective check on the reliability of the

transfer process, the Proposal required electronic recordkeepers to

maintain written operational procedures and controls that would provide

accountability over both the initial entry of required records to the

electronic storage media and the entry of each change made to any such

records.\10\ Second, due to practical limitations on the Commission's

ability to process data stored in the full range of available formats

and coding structures on the full range of storage media available to

recordkeepers, the Proposal required recordkeepers to provide copies of

requested records on ``Commission compatible machine-readable media''

with the format and coding structure specified in the request.\11\

Third, like the SEC's rules, the Proposal required recordkeepers using

electronic storage media to keep available for inspection ``all

information necessary to access records and indexes maintained on

electronic storage media * * *'' \12\

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\10\ The Proposal indicated that the written operational

procedures and controls should provide for the systematic collection

of data that includes the identities of individuals inputting

records and making changes as well as the identity of any new

document created and record changed.

\11\ Proposal at 30699. The Proposal noted that ``compatible

machine-readable media'' would be defined in accordance with

Commission Regulation 15.00(1).

\12\ Proposal at 30674. This condition anticipated situations in

which electronic recorkeepers had stored required records but were

unable or unwilling to provide Commission representatives with an

appropriate means to view and copy specified documents. The Proposal

did recognize that the required information might not be freely

available to recordkeepers that obtained their storage technology

from third-party vendors. As a result, the Proposal permitted

recordkeepers to employ escrow agreements to protect the third-party

vendor's proprietary rights.

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[[Page 28737]]

The Proposal contained a final, additional condition on

recordkeepers who stored all required records or all of a particular

class of required records solely on electronic storage media. To

address those situations in which such a recordkeeper was unable or

unwilling to provide Commission representatives with an appropriate

means to view and copy specified records and failed to maintain or

permit inspection of the information necessary to access requested

records, the Proposal required such recordkeepers to enter into an

arrangement with a third-party Technical Consultant.\13\

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\13\ Such recordkeepers must provide the Technical Consultant

with access to the storage media containing their required records,

and the Technical Consultant must (1) have the ability to download

information from the recordkeeper's storage media to any medium

acceptable under Regulation 1.31 and (2) undertake to provide

Commission representatives with access to the records stored on the

recordkeeper's storage media including, as appropriate, arrangement

for downloading the records in the format designated by Commission

representatives.

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III. Final Rules

The Commission received nine comments on the Proposal. Commenters

included the National Futures Association (``NFA''), four designated

futures exchanges, two commodity industry associations, and First

Options of Chicago, Inc. (``FOC''), a registered futures commission

merchant (``FCM''), which submitted two comments.\14\ Most commenters

praised the Commission for proposing revisions to its recordkeeping

requirements. One commodity exchange praised the Proposal for giving

recordkeepers ``flexibility to use technological advances in the

electronic storage media to reduce the costs associated with record

retention.'' \15\ A commodity industry association commended the

Commission for moving toward a more generic, performance-based approach

to the definition of permissible record storage technology. Another

commodity exchange agreed that aspects of the Proposal could lead to

improvement in both the security and availability of required records.

NFA characterized the Proposal as ``a significant step in the right

direction * * *.\16\

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\14\ One of FOC's submissions was a petition to amend Regulation

1.31, which was received shortly before the Commission published its

Proposal. To avoid undue delay, the Commission decided to publish

the Proposal and to treat this submission as a general comment on

the issues raised. FOC later filed a written submission responding

more specifically to the issues raised in the Proposal.

\15\ Chicago Board of Trade Comment at 1.

\16\ NFA Comment at 1.

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In view of the significant number of firms subject to regulation

under both the federal commodity and securities laws, the final

regulations recognize the value of maintaining consistency, where

possible, between the Commission's approach to recordkeeping and that

of the SEC. The regulations do not reflect strict conformity with the

regulations the SEC adopted in 1997, however, because the Commission

concluded that there were significant differences between the

commodities and securities industry that justified retaining certain of

its current rules.\17\

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\17\ In addition to the mandate that original written trading

cards and order tickets be maintained for five years, these include

requirements that recordkeepers: (1) maintain indexes of

electronically stored records that are available for immediate

examination and permit the location of any particular record to be

immediately ascertained; (2) keep the information necessary to

access electronically stored records and indexes available for

immediate examination; and (3) provide copies of specified records

on Commission-compatible machine-readable media with the format and

coding structure specified in the request.

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The comments focused primarily on five areas, each of which is

discussed below.

A. Maintaining Original Written Trading Cards and Order Tickets

The Proposal permitted recordkeepers to transfer most categories of

records to micrographic or electronic storage media immediately,

eliminating the need to keep original records for two years. However,

original trading cards and customer order tickets were required to be

maintained for the full five-year period. A majority of commenters

cited cost, efficiency and security concerns in questioning why the

Commission declined to permit written trading cards and customer orders

to be stored electronically. Both commodity industry associations

emphasized that firms incur significant costs organizing, indexing, and

storing order tickets and trading cards. FOC noted that firms also

incur significant costs to retrieve such records, and one exchange

estimated that it expended $100,000 each year to retrieve records

requested under Commission Regulation 1.31. Commenters also questioned

why retention of original trading cards and order tickets is an

important element of an effective audit trail for futures transactions,

particularly since the SEC permits electronic storage of written

trading cards and order tickets. One commodity industry association

urged the Commission to ``consider whether the high cost and burden of

maintaining original written orders and trading cards is

disproportionate to the limited use of these documents in enforcement

cases.'' \18\

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\18\ FIA Comment at 4.

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The Commission recognizes that electronic storage of written

trading cards and order tickets could reduce storage costs, increase

the efficiency of the retrieval process, and help eliminate certain

security problems attendant to the storage of paper records.

Nevertheless, given the importance these original records continue to

play in the futures industry, the Commission believes that it would be

imprudent to rely solely on electronic versions of these records at

this time. Although the SEC permitted electronic storage of these

documents, it recognized the need for caution in this area and rested

its decision to eliminate the requirement that recordkeepers maintain

originals largely on the diminished role such written records play due

to the prevalence of electronic order routing in the securities

industry.\19\

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\19\ 62 FR 6471.

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Review of written trading records for differences in the instrument

used to record apparently contemporaneous information remains a regular

feature of investigations focusing on potential trade practice or

allocation violations.\20\ FOC contended that current technology can

produce superb reproductions that make differences in hand writing and

time stamps clearly visible. Even if we assume this to be true,\21\

this argument does not address the full range of material information

Commission auditors and investigators may gather by examining original

written trading records. For example, the Commission's Division of

Enforcement often examines these records in the context of a variety of

alleged violations.\22\ If only electronically stored records were

available, errors in the scanning process, such as failing to process

information on

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both sides of a written order ticket, would deprive investigators of

material information. Moreover, even properly scanned records could

deprive investigators of currently available information. For example,

it is unlikely that investigators could distinguish ink colors on

scanned documents or detect either erasure or the use of products such

as white out. This type of discrepancy may be important in establishing

that a participant in the transaction inserted some information on a

trading card or order ticket after the bulk of the information had

already been recorded.\23\

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\20\ Indeed, Commission precedent indicates that such

differences--usually detected by noting differences in the color of

the ink on the document--can play an important evidentiary role in

cases raising trade practice allegations. See In re Russo, [Current

Transfer Binder] Comm. Fut. L. Rep. (CCH) 27,133 at 45,303 n. 9

(CFTC Aug. 20, 1997).

\21\ FOC submitted reproductions of two order tickets in support

of its contention. The limited nature of FOC's sample raises

significant questions about the validity of the broad inference it

draws. Moreover, the information recorded on the order tickets is

displayed in black and white. Aside from these limitations, FOC's

comment does not address even straight-forward implementation

problems such as ensuring that all material information is scanned

and stored--including time stamps and written information on the

back of order tickets.

\22\ Such violations include wash trading, accommodation

trading, direct or indirect trading ahead of or against customer

orders, offsetting or matching customer orders, unauthorized

trading, and inappropriate trade allocation.

\23\ For example, if information about the price, quantity and

contract is recorded on a written order ticket in one color ink, and

the number designating the identity of the customer is written in a

different color ink, an investigator might suspect that the trade

was allocated to a customer after it was executed and search for

additional indications that orders were being improperly allocated.

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Many commenters offered support for a compromise position suggested

by the FIA. Under this proposal, original written trading records would

be retained for one year. During this period, the written trading

records would be stored on ``high-quality micrographic or electronic

storage media that are reasonably able to detect alterations.'' \24\

After the initial year, recordkeepers would be free to destroy original

written trading records and to fulfill their obligations under

Regulation 1.31 by producing reproductions of the stored records.

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\24\ FIA Comment at 5. FIA indicates that the Commission could

maintain a check on the quality of available reproductions by

publishing a list of acceptable media or permitting recordkeepers to

seek Commission approval of a particular record storage medium or

system.

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The FIA proposal rests on an assumption that is not necessarily

correct. According to FIA, the experience of futures exchanges

indicates that auditors or compliance investigators generally request

access to written trading documents within one year of their creation.

FIA's implicit assumption is that there is no practical need to retain

original written trading documents for more than a year because the

experience of Commission auditors and investigators is fully consistent

with their exchange counterparts.

The Commission's experience with audits and investigations

indicates that there is no reliable basis for predicting the period of

time that any particular original written trading record will be

needed. For example, investigations of trade practice allegations are

frequently lengthy due to both the complexity of the underlying

transactions and efforts by many participants to disguise their intent

in entering the transactions. Information may not come to the

Commission's attention within a year of the wrongdoing, and the

suspicious activity often spans more than a one-year period. Moreover,

review of written trading records from a multi-year period may reveal

the type of pattern of suspicious trading that facilitates prosecution

of trade practice violations.\25\

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\25\ Participants in a suspicious transaction often seek to

undermine the significance of suspicious circumstances by claiming

that they are the product of peculiar market forces at the time of

the challenged transactions. Proof that the participants have been

involved in a pattern of suspicious transactions undertaken under

varying market conditions over a period of months or years is often

the most effective rebuttal to such a claim.

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Given the legitimate needs of its auditors and investigators, the

Commission cannot endorse the one-year retention period proposed by

FIA. Nevertheless, the Commission is modifying staff audit and

investigative practices in order to permit recordkeepers to take

advantage of some of the benefits of electronic storage technology, yet

protect the Commission's interest in maintaining access to original

trading records. Under the revised practice, if a recordkeeper chooses

to transfer trading cards and customer order tickets to electronic

media, a recordkeeper initially may respond to a request for written

trading cards and order tickets by producing reproductions maintained

on electronic storage media unless the staff request specifically

provides to the contrary. Staff generally will review these

reproductions prior to requesting production of original written

trading cards or order tickets.\26\ If this review confirms that

further investigation or examination of original trading records is

unwarranted, the recordkeeper's original trading cards and order

tickets may remain in storage.

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\26\ If staff is at a point in its review that indicates a

request for original written trading records is inevitable, it need

not waste either its own or the recordkeeper's resources by

initially requesting reproductions.

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While recordkeepers transferring original written trading documents

to electronic storage media will incur some additional costs, they also

may obtain substantial benefits from this change in policy. For

example, recordkeepers should be able to reduce retrieval costs, to

locate requested records more expeditiously, and to improve the

security of their stored original records.\27\ Commission auditors and

investigators should also benefit by obtaining more expeditious and

complete responses to their requests. Of course, the success of this

process will depend on the ability of recordkeepers not only to select

electronic storage systems that will produce high quality

reproductions, but also to manage the implementation challenges likely

to arise in transitioning from a paper-based system properly. In

addition, Commission experience with recordkeepers who choose to make

records available on electronic storage media pursuant to this policy

should provide a basis for reassessing the continued need for retention

of original trading cards and order tickets.\28\

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\27\ For example, if access to stored original records is rarely

necessary, it will be less likely that records will be lost or

misplaced in the process of locating requested records.

\28\ Implementation of this policy change does not require any

revision to the rules. By holding out the prospect of reduced

retrieval costs, the policy encourages recordkeepers to begin the

transition to electronic storage systems that promise greater

efficiency and security. Nevertheless, recordkeepers will still be

obliged to maintain the original version of trading cards, documents

on which trade information is originally recorded in writing, and

written orders required to be kept pursuant to Commission Regulation

1.35(a), (a-1)(1), (a-1)(2) and (d) for five years and to produce

those records in response to a request by an appropriate Commission

representative.

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B. Timeliness of Responses to Production Requests

Under current requirements, original records must be produced

``promptly'' and reproductions stored on micrographic media or optical

disk must be produced ``immediately.'' Some commenters believed that

``immediately'' is an unduly vague standard. Commenters also emphasized

that this standard does not acknowledge the relevance of practical

circumstances that can delay production by even cooperative

recordkeepers. Thus, many commenters urged the Commission to require

that both original records and reproductions stored on micrographic or

electronic storage media be produced ``promptly.''

There is no evidence that the current dual production standard has

created any practical problems. While the rule grants Commission staff

broad discretion in determining when specified records should be

produced, none of the commenters has claimed that Commission staff have

abused this discretion by establishing arbitrary deadlines that ignored

relevant circumstances.\29\ Indeed, FIA's

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comment stated that Commission staff ``typically exhibits flexibility

when requesting documents to accommodate practical considerations.\30\

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\29\ The current standards do not describe a level of timeliness

that staff auditors and investigators must invariably demand from

recordkeepers. Indeed, Commission representatives frequently tailor

the deadline applicable to a particular document request in light of

the scope and nature of the request, as well as unusual or

unforeseen circumstances affecting a recordkeeper's ability to

respond quickly or completely. Nonetheless, because delay in the

production of required records can sometimes represent an undue

threat to the public interest, Regulation 1.31 grants Commission

representatives the discretion to specify production deadlines

sufficient to address such threats.

\30\ FIA Comment at 8.

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The ``immediately'' standard provides recordkeepers with notice of

the highest level of timeliness Commission representatives may demand

in seeking production. As indicated in the Proposal, Regulation 1.31

requires that reproductions stored on micrographic or electronic

storage media be produced ``immediately'' rather than ``promptly''

because, in general, it is easier to locate and to produce such

reproductions than to locate and to produce original records. The dual

standards make it clear that Commission auditors and investigators are

authorized to demand that reproductions be produced more quickly than

original records. At the same time, they require auditors and

investigators to weigh a recordkeeper's potentially more limited

ability to locate and produce original records in establishing a

deadline for their production.

The Commission recognizes that applicable deadlines should reflect

an evaluation of factors such as the volume of documents covered by a

request, competing requests from other regulators, or unusual and

unforeseeable circumstances that prevent the recordkeeper from

accessing electronically controlled records. Staff discretion, however,

plays a necessary role in an effective production process, and there is

no indication that staff has failed to exercise their discretion

sensibly.\31\ On the current record, there is no basis for imposing

further limitations on the discretion exercised by Commission auditors

and investigators.

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\31\ One commenter indicated that the production process under

Regulation 1.31 should be modeled on the discovery process in an

adjudicatory proceeding. The Regulation 1.31 process, however, is

specifically designed to avoid both the delay and diversion of

resources common to such an adversarial process. As a result,

Regulation 1.31 does not provide that a response can be delayed

until a recordkeeper's counsel has had an opportunity to review

requested records. Nor does it establish a process for settling

objections over issues such as breadth or relevance. Moreover,

recordkeepers are expected to manage their affairs in a manner that

permits them to fulfill the duties described in Regulation 1.31. For

example, recordkeepers using micrographic or electronic storage

systems are expected to retain a sufficient number of expert

personnel to meet their regulatory responsibilities. The absence of

a single individual due to sickness or vacation should not make it

impossible for the recordkeeper to make an immediate response to an

auditor's or investigator's request in the infrequent circumstance

when immediacy is a critical component of the request, e.g. in a

financial crisis or where customer positions or other assets are at

risk.

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C. Retention of a Consultant

As noted above, the Proposal, like the SEC rules, required

recordkeepers who stored all required records or all of a particular

class of required records solely on electronic storage media to enter

into an arrangement with a third-party Technical Consultant.\32\

Commenters criticized this aspect of the Proposal for imposing a costly

burden that will discourage transition to electronic storage systems.

Commenters also argued that this safeguard will threaten the

confidentiality of information maintained by recordkeepers.

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\32\ Such recordkeepers must provide the Technical Consultant

with access to the storage media containing their required records,

and the Technical Consultant must (1) have the ability to download

information from the recordkeeper's storage media to any medium

acceptable under Regulation 1.31 and (2) undertake to provide

Commission representatives with access to the records stored on the

recordkeeper's storage media including, as appropriate, arrangement

for downloading the records in the format designated by Commission

representatives.

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The Commission has decided to adopt this aspect of the Proposal

without change. The SEC has required this type of safeguard since

1993.\33\ A significant number of Commission registrants are subject to

the SEC's recordkeeping requirements, and none of the comments on the

Proposal describes any problems with the implementation of this

safeguard under the SEC's rules. Recordkeepers are only required to

enter an arrangement with a Technical Consultant if they choose to

store all required records or all of a particular class of required

records solely on electronic storage media. As a result, recordkeepers

may protect themselves from costs related to retaining a Technical

Consultant by maintaining backup copies of electronically stored

records in either a hard copy or micrographic version. As to

confidentiality concerns relating to a Technical Consultant's access to

required records, recordkeepers may protect themselves by entering into

appropriate confidentiality agreements with their Technical

Consultants. In short, the objections that have been raised by

commenters do not establish that there are circumstances unique to the

futures industry that warrant a deviation from the SEC policy.\34\

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\33\ As noted above, the SEC adopted this safeguard as part of

its 1997 rulemaking. In June 1993, however, the SEC's Division of

Market Regulation issued a no-action letter allowing broker-dealers

to utilize optical storage technology for recordkeeping under

certain conditions. The availability of a third-party backup was one

of the conditions to this relief. See Letter from Michael A.

Macciaroli, Associate Director, Division of Market Regulation, SEC

to Michael D. Udoff, Chairman, Ad Hoc Record Retention Committee,

Securities Industry Association (June 18, 1993), 1993 WL 246230

(SEC).

\34\ The Commission does not intend that Commission

investigators or auditors regularly seek required records from

Technical Consultants. Indeed, staff will only seek performance of

the Technical Consultant's undertaking with the Commission when the

recordkeeper itself has shown that it is unable or unwilling to meet

its regulatory obligations.

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D. Production on Commission Compatible Machine-Readable Media

The Proposal required recordkeepers using electronic storage media

to provide copies of requested records on Commission compatible

machine-readable media (as defined by Commission Regulation 15.00(l))

\35\ with the format and coding structure specified in the request. Two

commenters stated that neither the Proposal nor Regulation 15.00(l)

provides adequate notice of either the range of media that the

Commission will deem compatible or the range of formats and coding

structures that may be required. In response to these comments, the

Commission has decided to provide guidance about the intent underlying

this provision and to direct staff to take steps to provide

recordkeepers with ongoing notice of the applicable requirements.\36\

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\35\ Commission Regulation 15.00(l) provides that the term

compatible data processing media means: [D]ata processing media

approved by the Commission or its designee. The rule delegates the

Commission's approval authority to the Executive Director and

provides that the Executive Director may designate employees to

exercise the approval authority on her behalf.

\36\ When the Commission amended Regulation 15.00(l) in 1997, it

deleted references to specific media in light of comments suggesting

that a regulatory definition was impractical because electronic

media are evolving at such a rapid pace. 62 FR 24026, 24028 (May 2,

1997).

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The requirement that recordkeepers provide documents to the

Commission in one of the many identified formats arises out of

practical limitations on the Commission's ability to process data

stored in the full range of available formats and coding structures on

the full range of storage media available to recordkeepers. The

Commission uses standard desktop tools including Microsoft Office

Professional 97. Recordkeepers using storage systems with compatible

format and coding structures should not experience significant problems

providing Commission auditors and investigators with acceptable

machine-readable media. Records that include data files and images will

be acceptable if accompanied by appropriate

[[Page 28740]]

information.\37\ Where the records are from a relational data base

management system, the Commission would prefer that the recordkeeper

convert the records to an acceptable data file format. Under

appropriate conditions, however, the Commission will also accept such

records in another format.\38\ Where the records are from a different

source, providers will need to coordinate with the Commission to

determine acceptability.

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\37\ For records that include data files, the required

information includes:

(1) how to identify individual records and record types;

(2) how to identify individual fields within records;

(3) how the individual fields and record types are defined; and

(4) the format of each quantitative field and the meaning of

each field value for other fields.

For records that include images, the required information

includes:

(1) how any data files are linked to images;

(2) how to identify individual images; and

(3) the format of the images.

The Commission uses ``Wang Imaging for Windows 95.'' The

Commission will accept images in another format if:

(1) software is provided with the records that makes it feasible

to view and print the images;

(2) this software will run under Windows NT or Windows 95/98;

(3) this software can be freely provided to the Commission under

the terms of the provider's licensing agreements with the concerned

software vendor(s); and

(4) information is provided on how individual images can be

accessed.

\38\ The applicable conditions include:

(1) the records are accompanied by software that makes it

feasible to access the records using standard office tools,

(2) this software will run under Windows NT or Windows 95/98,

(3) this software can be freely provided to the Commission under

the terms of the provider's licensing agreements with the concerned

software vendor(s),

(4) information is provided on how the individual fields and

record types are defined, and

(5) information is provided on the format of each quantitative

field and the meaning of each field value for other fields.

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Recordkeepers can provide information to the Commission on a number

of different media. Clearly, a small file can be placed on a diskette

or set of diskettes. CD-ROM, 4mm tape, 30 GB DLT tape, nine-track tape

and IBM 3490 cartridge tapes are also acceptable. Absent security

concerns, email attachments and FTP transmitted files are acceptable.

Providers will need to coordinate with the Commission if different

media are contemplated.

Of course the Commission's capabilities in this regard will change

over time. To provide affected recordkeepers with continuous notice of

what is currently acceptable, the Commission is modifying current staff

practice to require preparation of an updated list of formats and

coding structures as changes are made. Notice of any changes to the

list will be available both in writing and on the Commission's web

page, and an updated list will be published in the Federal Register.

E. Waiver of Privilege

Consistent with current Commission requirements, the Proposal

provided that recordkeepers employing micrographic or electronic

storage systems must agree to waive any privilege, claim of

confidentiality or other objection to the disclosure of non-Commission-

required records stored on the same individual medium as Commission-

required documents. Some commenters characterized this approach as

inflexible and urged the Commission to adopt an approach modeled on ABA

Op. No. 92-368 (Standing Committee on Ethics and Professional

Responsibility, Nov. 10, 1992).\39\

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\39\ In that opinion, the American Bar Association Standing

Committee on Ethics and Professional Responsibility addressed

circumstances in which an attorney inadvertently sends another

lawyer privileged or otherwise confidential materials belonging to

an opposing party. The committee found that a lawyer receiving such

confidential material has a professional obligation, when he or she

recognizes opposing counsel's error, to avoid further review of the

material. The committee also concluded that the affected lawyer

should notify opposing counsel of the error and follow counsel's

directions as to the disposition of the material.

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The Commission has decided that the waiver language should be

deleted from Regulation 1.31. While courts are not in agreement about

the proper application of the ``inadvertent waiver'' theory discussed

in the ABA's Opinion, the Commission does not believe that a

recordkeeper should be precluded by rule from raising a question about

privilege if a privileged document has been inadvertently stored and/or

produced on the same medium as Commission-required documents.\40\ In an

effort to avoid this problem, the deleted waiver language will be

replaced with the current Commission requirement that recordkeepers

store Commission-required records on a separate individual medium from

non-Commission-required records. Waiver, however, will no longer be a

mandatory consequence of failing to fulfill this segregation

requirement, at least by operation of regulation.

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\40\ As is currently the case with all Commission-required

records, recordkeepers may not deny authorized Commission

representatives access to any individual storage medium that

includes Commission-required records or delay production while the

individual storage medium is reviewed for the presence of privileged

material. The final rule merely eliminates the regulatory inference

that the commingling of Commission-required records with non-

Commissioned-required records necessarily amounts to a waiver of any

privilege otherwise covering the latter category of records.

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F. Other Issues

1. Generic standards

Several commenters urged the Commission to adopt generic standards

of accessibility, security, and reliability that do not distinguish

between original records and eligible substitutes. One of the commodity

industry associations argued that the adoption of generic performance

standards would increase flexibility and decrease the likelihood that

the applicable standards would become ``outdated'' due to continued

technological developments. One exchange commenter claimed that such a

unitary approach would ensure consistency and lessen confusion.

A generic approach may have certain advantages in an area likely to

be affected by rapid technological change. Some comments on the

Proposal, however, illustrate the weaknesses of any approach that fails

to provide sufficiently specific notice of the procedures the

Commission considers necessary to a reliable system of records. These

comments suggest that, absent specific guidance, many industry

participants would interpret their recordkeeping duties in a manner the

Commission views as incompatible with the public interest.\41\

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\41\ FOC argued that any required record should be deemed

accessible if produced within 10 days. One commodity industry

association noted that Regulation 1.31 does not include any

requirements for the security and integrity of paper records and

argued that firms have no duty to supervise the security and

reliability of hard copy records under the generic standard set

forth in Commission Regulation 166.3. One exchange commenter

indicated that it would be burdensome to require recordkeepers to

maintain an accurate and complete index of records stored on

micrographic or electronic storage media.

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More importantly, none of the commentators that urged adoption of

more generic standards offered the type of specific proposal that would

permit the Commission to make a reasoned evaluation of the practical

costs and benefits of a more generic approach. Indeed, none of the

commenters cited to generic standards adopted by a state or federal

regulatory body with responsibilities comparable to those the CEA

entrusts to the Commission. The absence of any specific proposals may

be a product of the futures industry's limited experience with the

design or implementation of large-scale electronic storage systems.\42\

We emphasize that

[[Page 28741]]

movement toward more generic standards may well be appropriate as

industry experience and expertise develop. Indeed, as part of its

ongoing evaluation of developments warranting additional amendments to

its recordkeeping requirements, the Commission encourages the

submission of specific proposals for generic standards that both

provide recordkeepers with the flexibility necessary to maximize the

cost reduction and time savings available from improved storage

technology and ensure that Commission auditors and investigators

maintain timely access to a reliable system of records.

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\42\ Even if the capabilities of electronic storage systems meet

the high expectations of their proponents, the Commission expects

that the transition process from paper-based systems to electronic-

based systems will involve implementation problems requiring

significant adjustments. If the security, reliability, and

accessibility of the recordkeeping process are to be protected

during this period of learning and adjustment, it is important that

recordkeepers have clear notice of their ongoing obligations under

Regulation 1.31. It is equally important that recordkeepers keep the

Commission informed of the experience gained during this period so

that the Commission can develop a reliable basis for making

necessary adjustments to its rules.

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2. Format of Storage Media

One exchange commenter noted that one of the Proposal's four

characteristics for defining electronic storage media could be

misconstrued as requiring that the storage system itself exclusively

preserve records in a non-rewritable, non-erasable format. It suggests

that such an interpretation could disqualify CD-ROM storage systems

with rewritable CD-ROM capabilities. The Commission agrees that the

medium, not the storage system itself, must exclusively preserve

records in a non-rewritable, non-erasable format.

3. Escrow Agreements

Two exchange commenters opposed the Proposal's requirement that

recordkeepers using electronic storage media keep available for

inspection all information necessary to access records and indexes

maintained on electronic storage media or, in the alternative, place

such information in escrow and, as necessary, update the information.

These commenters raised the possibility that third-party vendors may be

unwilling to enter into source code escrow agreements. As noted in the

Proposal, however, such escrow agreements are a common feature of

software licensing agreements. There is no indication that the similar

safeguard in the SEC's rules has resulted in problems with third-party

vendors. Given the speculative nature of the information provided by

the commenters, modification of this safeguard is not warranted.

4. Written Procedures

Several commenters objected to the Proposal's requirement that

electronic recordkeepers maintain written operational procedures and

controls that would provide accountability over both the initial entry

of required records to the electronic storage media and the entry of

each change made to any such records. As noted in the Proposal, the

Commission believes that all recordkeepers must have and enforce

procedures to keep their required records from being altered or

destroyed.\43\ The Proposal's specific requirements for electronic

storage systems reflect the special security/integrity concerns that

attend the transition process from paper-based recordkeeping systems.

While experience may prove these special precautions unnecessary, the

arguments raised by the commenters do not warrant their deletion at

this time.

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\43\ Proposal at 30672.

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5. Adjusting Requirements in Response to Technological Change

Several commenters noted that some of the Proposal's requirements

may quickly become outdated due to rapid developments in the technology

underlying electronic storage media. These commenters observed that

addressing the necessary adjustments through the rulemaking process may

prove unduly slow, costly and inflexible.

The rulemaking process can play an important role in identifying

and removing such obstacles. While the notice and comment process that

underlies rulemaking can result in limited delays, this process helps

ensure that the Commission's deliberations are informed by the

perspectives of a broad range of interested parties. Moreover, as in

this instance, the rulemaking process can play an important rule in

harmonizing the approach different regulators take to common areas of

concern, thereby minimizing the regulatory burden imposed on firms

subject to dual regulation.

The Commission has adequate tools to address short-term

inefficiencies in the regulatory process. On several occasions during

the past two years, the Commission has provided interim relief from the

current requirements of Rule 1.31 to Commission registrants using

advanced technology.\44\ This relief has helped minimize obstacles to

the adoption of new technology while the Commission addressed the need

for final amendments to Rule 1.31. If circumstances warrant, similar

relief can be made available in the future.

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\44\ The Commission has permitted these registrants to

substitute compliance with the SEC's recordkeeping requirements for

compliance with the current requirements of Rule 1.31. See note 2,

supra.

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IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601, et seq.,

611, requires that, in adopting rules and regulations, all federal

agencies consider their impact on small entities. In accordance with

Section 601(3) of the RFA, the Commission published a ``Policy

Statement of Definitions of Small Entities for Purposes of the

Regulatory Flexibility Act,'' 47 FR 18618 (Apr. 30, 1982). In that

statement,\45\ the Commission indicated that some classes of persons

were excluded from the definition of small entities. These include:

futures commission merchants registered or required to be registered;

floor brokers employed by registered futures commission merchants;

commodity pool operators registered or required to be registered; and

large traders in the futures market. The Commission considers other

entities to be small under particular facts and circumstances. These

include: futures commission merchants exempt from registration;

commodity pool operators exempt from registration; introducing brokers;

floor brokers not employed by futures commission merchants; floor

traders; and commodity trading advisors. Because the rules discussed

herein will affect the full spectrum of Commission registrants, it is

likely that small entities within the meaning of the RFA will be

affected.

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\45\ The Commission subsequently clarified some of the

definitions See 48 FR 35276 (Aug. 3, 1983); 55 FR 13550 (Apr. 11,

1990); 58 FR 40347 (Jul. 28, 1993).

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The final rules would generally expand the category of record

storage systems permissible under the Commission's rules. The

Commission anticipates that these rules will increase small entities'

freedom to tailor their record storage systems to the overall needs of

their businesses. The final rules will have no impact on a small entity

chooses to maintain a paper-based record storage system. However, if a

small entity chooses to use micrographic storage media, it may incur

costs related to creation of the duplicate record and storage at a

location separate from the micrographic record. Costs can be reduced by

moving the hard copies of the records to a separate location.

[[Page 28742]]

The final rules will permit small entities that choose to use

electronic storage media for their storage record systems to select

systems that may be less costly and simpler to manage. The final rules

will impose limited additional burdens on these entities, including

requirements that the recordkeeper: (1) provide a representation that

the system meets pertinent regulatory requirements prior to converting

to an electronic storage system; (2) create a duplicate of both

required records and an index of those records and maintain the

duplicate at a separate location; (3) create and maintain an audit

system for transferring records to electronic storage media; (4) take

steps to ensure Commission access to information necessary to download

records from the electronic storage media; and (5) provide an

independent source for the downloading of records that are maintained

solely on electronic storage media. The Commission anticipates that

small entities will not convert their recordkeeping systems to

electronic storage media unless the accompanying burdens are outweighed

by the financial savings and operational efficiency that would result

from the change to electronic storage media.

The Chairperson, on behalf of the Commission, hereby certifies,

pursuant to 5 U.S.C. 605(b), that the action taken herein will not have

a significant economic impact on a substantial number of small

entities.

B. Paperwork Reduction Act

When publishing final rules, the Paperwork Reduction Act of 1995

\46\ (``PRA'') imposes certain requirements on federal agencies

(including the Commission) in connection with their conducting or

sponsoring any collection of information as defined by the PRA. In

compliance with the PRA, these final rules and/or their associated

information collection requirement inform the public of:

\46\ Pub. L. 104-13 (May 13, 1995).

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(1) The reasons the information is planned to be and/or has been

collected; (2) the way such information is planned to be and/or has

been used to further the proper performance of the functions of the

agency; (3) an estimate, to the extent practicable, of the average

burden of the collection (together with a request that the public

direct to the agency any comments concerning the accuracy of this

burden estimate and any suggestions for reducing this burden); (4)

whether responses to the collection of information are voluntary,

required to obtain or retain a benefit or mandatory; (5) the nature

and extent of confidentiality to be provided, if any; and (6) the

fact that an agency may not conduct or sponsor, and a person is not

required to respond to, a collection of information unless it

displays a current valid OMB control number.

The Commission previously submitted these rules in proposed form

and their associated information collection requirement to the Office

of Management and Budget. The Office of Management and Budget approved

the collection of information associated with these rules on October

24, 1998, and assigned OMB control number 3038-0022, Rules Pertaining

to Contract Markets and Their Members, to these rules. The burden

associated with this entire collection 3038-0022, including these final

rule amendments, is as follows:

Average burden hours per response: 3,609,89.

Number of respondents: 15,893.

Frequency of response: On occasion.

The burden associated with the final rule amendments, is as

follows:

Average burden hours per response: 17.50

Number of respondents: 3,412.

Frequency of response: On occasion.

Persons wishing to comment on the information required by these

final rules should contact the Desk Officer, CFTC, Office of Management

and Budget, Room 10202, NEOB, Washington, DC 20503, (202) 395-7340.

Copies of the information collection submission to OMB are available

from the CFTC Clearance Officer, 1155 21st Street N.W., Washington, DC

20581, (202) 418-5160.

List of Subjects in 17 CFR Part 1

Recordkeeping requirements.

Accordingly, 17 CFR part 1 is amended as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,

6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,

12c, 13a, 13a-1, 16, 16a, 19, 21, 23, 24.

2. Section 1.31 is amended by revising paragraphs (b), (c), and (d)

to read as follows:

Sec. 1.31 Books and records; keeping and inspection.

* * * * *

(b) Except as provided in paragraph (d) of this section, immediate

reproductions on either ``micrographic media'' (as defined in paragraph

(b)(1)(i) of this section) or ``electronic storage media'' (as defined

in paragraph (b)(1)(ii) this section) may be kept in that form for the

required time period under the conditions set forth in this paragraph

(b).

(1) For purposes of this section:

(i) The term ``micrographic media'' means microfilm or microfiche

or any similar medium.

(ii) The term ``electronic storage media'' means any digital

storage medium or system that:

(A) Preserves the records exclusively in a non-rewritable, non-

erasable format;

(B) Verifies automatically the quality and accuracy of the storage

media recording process;

(C) Serializes the original and, if applicable, duplicate units of

storage media and creates a time-date record for the required period of

retention for the information placed on such electronic storage media;

and

(D) Permits the immediate downloading of indexes and records

preserved on the electronic storage media onto paper, microfilm,

microfiche or other medium acceptable under this paragraph upon the

request of representatives of the Commission or the Department of

Justice.

(2) Persons who use either micrographic media or electronic storage

media to maintain records in accordance with this section must:

(i) Have available at all times, for examination by representatives

of the Commission or the Department of Justice, facilities for

immediate, easily readable projection or production of micrographic

media or electronic storage media images;

(ii) Be ready at all times to provide, and immediately provide at

the expense of the person required to keep such records, any easily

readable hard-copy image that representatives of the Commission or

Department of Justice may request;

(iii) Keep only Commission-require records on the individual medium

employed (e.g., a disk or sheets of microfiche);

(iv) Store a duplicate of the record, in any medium acceptable

under this regulation, at a location separate from the original for the

period of time required for maintenance of the original; and

(v) Organize and maintain an accurate index of all information

maintained on both the original and duplicate storage media such that:

(A) The location of any particular record stored on the media may

be immediately ascertained;

(B) The index is available at all times for immediate examination

by

[[Page 28743]]

representatives of the Commission or the Department of Justice;

(C) A duplicate of the index is stored at a location separate from

the original index; and

(D) Both the original index and the duplicate index are preserved

for the time period required for the records included in the index.

(3) In addition to the foregoing conditions, persons using

electronic storage media must:

(i) Be ready at all times to provide, and immediately provide at

the expense of the person required to keep such records, copies of such

records on such approved machine-readable media as defined in

Sec. 15.00(1) of this chapter which any representative of the

Commission or the Department of Justice may request. Records must use a

format and coding structure specified in the request.

(ii) Develop and maintain written operational procedures and

controls (an ``audit system'') designed to provide accountability over

both the initial entry of required records to the electronic storage

media and the entry of each change made to any original or duplicate

record maintained on the electronic storage media such that:

(A) The results of such audit system are available at all times for

immediate examination by representatives of the Commission or the

Department of Justice;

(B) The results of such audit system are preserved for the time

period required for the records maintained on the electronic storage

media; and

(C) The written operational procedures and controls are available

at all times for immediate examination by representatives of the

Commission or the Department of Justice.

(iii) Either

(A) Maintain, keep current, and make available at all times for

immediate examination by representatives of the Commission or

Department of Justice all information necessary to access records and

indexes maintained on the electronic storage media; or

(B) Place in escrow and keep current a copy of the physical and

logical format of the electronic storage media, the file format of all

different information types maintained on the electronic storage media

and the source code, documentation, and information necessary to access

the records and indexes maintained on the electronic storage media.

(4) In addition to the foregoing conditions, any person who uses

only electronic storage media to preserve some or all of its required

records (``Electronic Recordkeeper'') shall, prior to the media's use,

enter into an arrangement with at least one third party technical

consultant (``Technical Consultant'') who has the technical and

financial capability to perform the undertakings described in this

paragraph (b)(4). The arrangement shall provide that the Technical

Consultant will have access to, and the ability to download,

information from the Electronic Recordkeeper's electronic storage media

to any medium acceptable under this regulation.

(i) The Technical Consultant must file with the Commission an

undertaking in a form acceptable to the Commission, signed by the

Technical Consultant or a person duly authorized by the Technical

Consultant. An acceptable undertaking must include the following

provision with respect to the Electronic Recordkeeper:

With respect to any books and records maintained or preserved on

behalf of the Electronic Recordkeeper, the undersigned hereby

undertakes to furnish promptly to any representative of the United

States Commodity Futures Trading Commission or the United States

Department of Justice (the ``Representative''), upon reasonable

request, such information as is deemed necessary by the

Representative to download information kept on the Electronic

Recordkeeper's electronic storage media to any medium acceptable

under 17 CFR 1.31. The undersigned also undertakes to take

reasonable steps to provide access to information contained on the

Electronic Recordkeeper's electronic storage media, including, as

appropriate, arrangements for the downloading of any record required

to be maintained under the Commodity Exchange Act or the rules,

regulations, or orders of the United States Commodity Futures

Trading Commission, in a format acceptable to the Representative. In

the event the Electronic Recordkeeper fails to download a record

into a readable format and after reasonable notice to the Electronic

Recordkeeper, upon being provided with the appropriate electronic

storage medium, the undersigned will undertake to do so, at no

charge to the United States, as the Representative may request.

(ii) [Reserved]

(c) Persons employing an electronic storage system shall provide a

representation to the Commission prior to the initial use of the

system. The representation shall be made by the person required to

maintain the records, the storage system vendor, or another third party

with appropriate expertise and shall state that the selected electronic

storage system meets the requirements set forth in paragraph (b)(1)(ii)

of this section. Persons employing an electronic storage system using

media other than optical disk or CD-ROM technology shall so state. The

representation shall be accompanied by the type of oath or affirmation

described in Sec. 1.10(d)(4).

(d) Trading cards, documents on which trade information is

originally recorded in writing, and written orders required to be kept

pursuant to Sec. 1.35(a), (a-1)(1), (a-1)(2) and (d) must be retained

in hard-copy for the required time period.

Issued in Washington, DC on May 21, 1999 by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 99-13514 Filed 5-26-99; 8:45 am]

BILLING CODE 6351-01-M