CHARLES SCHWAB & CO., INC.
101 Montgomery Street
San Francisco, California 94104
April 19, 2001
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-06-01 -- Proposed Rule: Electronic Recordkeeping by Investment Companies and Investment Advisers
Dear Mr. Katz:
Charles Schwab & Co., Inc. ("CS&Co"), along with its affiliate Charles Schwab Investment Management, Inc. ("CSIM" and together with CS&Co, "Schwab")1, appreciates the opportunity to comment on the Securities and Exchange Commission's ("Commission" or "SEC") recent proposal2 to amend the electronic recordkeeping provisions of Rule 31a-2 of the Investment Company Act of 1940 and Rule 204-2 of the Investment Advisers Act of 1940 in response to the Electronic Signatures in Global and National Commerce Act ("ESIGN").3 The proposed amendments would expand the circumstances under which funds and advisers may keep their records on electronic storage media.
Schwab Supports the Commission's Efforts to Expand the Recordkeeping Rules in Response to ESIGN
Schwab supports broadening Rule 31a-2 and Rule 204-2 to allow funds and advisers to keep records originally created on paper on electronic storage media with some modifications as set forth in our comments below. Schwab also supports the Commission's efforts to provide uniform requirements for how electronic records should be kept regardless of how they originated. These revisions are an important step forward for funds and advisers who choose to keep records in an electronic format and have previously relied on no-action positions to do so. For many funds and advisers, electronic storage capabilities are not just a convenience, but a necessity, in achieving a cost-effective way to organize and maintain a large volume of records.
Additionally, Schwab agrees with the overall comments on the proposals to revise Rule 31a-2 and Rule 204-2 submitted by the Securities Industry Association ("SIA"), the Investment Counsel Association of America ("ICAA") and the Investment Company Institute ("ICI"). In particular, we echo SIA's urging the Commission to grant broker-dealers the same recordkeeping flexibility as it proposes to grant funds and advisers.
Schwab Supports the Commission's View that Storage In WORM Format Is Unnecessary
Schwab applauds the Commission's decision not to require funds and advisers to store electronic records in a write once, read many ("WORM") format and the Commission's acknowledgement of the significant cost burdens associated with requiring records to be stored in WORM format. These costs and the lack of experience of users altering stored records are both justifications for not imposing WORM.
There are additional justifications. The Commission's decision is also consistent with the intent of ESIGN to permit entities to comply with regulatory recordkeeping provisions by retaining electronic records. Indeed, the imposition of a WORM storage requirement on funds and advisers would run contrary to Section 104(b)(2) of ESIGN which requires that any regulation or guidance on electronic records: not add to the requirements of Section 101(d)'s accuracy and accessibility provisions; be "substantially equivalent" to the requirements imposed on non-electronic records; and not impose "unreasonable costs on the acceptance and use of electronic records" (emphasis added). We note that were the Commission to specify a particular technology or technical specification such as WORM, notwithstanding ESIGN's general mandate, the Commission would need to engage in substantial quantitative analysis of the costs and benefits, including at a minimum, data relating to presumed benefits, cost data on the initial investment in such technology, the ongoing costs of operating such a system, and/or the additional costs associated with operating the mandated system alongside of more efficient record storage systems that are used for non-regulatory purposes.
In addition, WORM-compatible storage media is no longer capable of coping with the volume of electronic records, including e-mail. Nor does current WORM storage afford the safeguards from loss, alteration or destruction that the Commission seeks, as it is not tamperproof.
For the foregoing reasons, as well as the additional cost and efficiency saves to be gained from a consistent record storage approach across all entities of an enterprise, we encourage the Commission to seriously consider extending the model it has proposed for funds and advisers to all related firms of a broker-dealer and the broker-dealer itself. These are compelling arguments for technology-neutral record storage rules for all Commission-regulated entities.
Clarity of Recordkeeping Rules Generally
We also applaud the Commission for its effort to clarify and modernize recordkeeping rules for funds and advisers. We note that the proposed rule revisions leave in tact the particular records to be stored by advisers and funds. We concur that the current rules are adequate in their categories of retention, and that there is no need for a generalized catchall retention requirement. We consider the approach of Rules 204-2 and Rules 31a-1 and 31a-2, respectively, to be appropriate models for SEC record retention requirements and urge the Commission to follow this approach in its broker-dealer recordkeeping rules. By contrast, one of the broker-dealer record retention rules, Rule 17a-4, purports to require retention for three years of any other records relating to "the business as such" of the firm. We believe that this catchall approach is unduly vague, economically burdensome, and at odds with good regulatory policy. We urge the Commission to conform Rule 17a-4 to the category-based recordkeeping rules for advisers and funds. We are encouraged by recent dialogue with Commission staff demonstrating its willingness to meet with the industry on broker-dealer electronic recordkeeping rules.
The Timing of When Records Must Be Provided to Examiners Should Continue to Be Based On a Facts and Circumstances Test
The proposed revisions would require funds and advisers to produce requested documents stored on electronic or micrographic media to the Commission no later than one business day after the request, regardless of the nature of the request, or factors such as the volume of documents requested and the location of the requested information. In contrast, the existing rules permit flexibility by requiring funds and advisers to produce electronic records to the Commission "promptly."
Schwab urges the Commission to retain the current facts and circumstances test inherent in the term "promptly." In some instances, it will be physically impracticable for funds and advisers to produce records within a one business day timeframe. For instance, where the electronic records requested are kept by a third party, one business day may not be sufficient for the fund or adviser to communicate the information to the third party and for the third party to locate the records and deliver them to the fund or the adviser. Where electronic records, such as microfiche or optical storage discs, are kept at an offsite storage facility, it may take more than one business day for the records to be retrieved. It also may take funds and advisers more than one business day to cull their records for specific records that are responsive to the request and arrange those records as requested.
In the past, the Commission has permitted funds and advisers to produce records within varying time frames. The Commission has indicated in no-action letters that a longer time period is allowable in certain circumstances.4 Moreover, the existing rules do not prescribe a time period for producing records stored in paper form to the Commission.
In addition, the current facts and circumstances test provides a mechanism for examiners to work with funds and advisers to determine both the timing and process for producing records to the Commission in light of the nature of the request. A hard and fast one business day deadline eliminates this necessary flexibility.
The Requirement that the Commission Be Provided With the Means to Search and Sort Records Should Not Be Adopted
The proposed rules would also require that funds and advisers provide the Commission with the means to access, search, view, sort and print requested electronic records. The Proposing Release explains that this new language is designed to eliminate the need, under the current requirements, that funds and advisers have facilities for immediate, easily readable projection of micrographic storage media and for producing easily readable enlargements.
It is unclear from the Proposing Release, however, why the Commission has imposed a requirement that funds and advisers provide the Commission with the means to "search" and "sort" requested documents or what this denotes. Schwab strongly objects to any meaning that goes beyond requiring a fund or adviser to arrange its records in a way that allows the fund or adviser to easily locate the records or that the Commission be granted access to a particular requested record and the ability to print and view the record. If, indeed the provision is intended to mean no more than this, we believe that the requirement is already set forth in proposed Rules 31-a2(f)(2)(i) and 204-2(g)(2)(i). Significant cost burdens would be associated with an enhanced "search" and "sort" recordkeeping requirement including costs associated with technological changes to software and hardware. The Commission would have to perform a substantial quantitative analysis of the costs and benefits associated with an enhanced requirement if it pursued such a proposal in the face of ESIGN's general mandate that electronic recordkeeping regulation not impose "unreasonable costs on the acceptance and use of electronic records" and that requirements for keeping electronic records be "substantially equivalent" to those for non-electronic records.5 No such analysis was included in the Proposing Release. Accordingly, we urge the Commission to eliminate this requirement from the final rule.
Requiring Funds and Advisers to Limit Access to Electronic Storage Media to Properly Authorized Personnel Is Unnecessary
Schwab recommends that the proposed requirements that funds and advisers limit access to records stored on electronic storage media to "properly authorized personnel" and the Commission (and, in the case of funds, to the fund's directors) be eliminated. It is unnecessary in light of the proposed requirements of Rules 31a-2(f)(3)(i) and 204-2(g)(3)(i) that funds and advisers reasonably safeguard their records from loss, alteration or destruction. As the Commission itself has found, there have been little or no problems with funds and advisers altering stored records, thus indicating no need for this requirement.
Clarification Is Needed That the General Requirements Section of the Proposed Revisions Applies Only to Electronic and Micrographic Media
The positioning of the proposed "General Requirements" section of Rules 31a-2(f)(2) and 204-2(g)(2) implies that the requirement is meant to apply only to electronic storage media and micrographic media and not also to other types of storage media such as paper. This interpretation, however, is not explicit in the proposed language. Therefore, Schwab urges the Commission to clarify that the "General Requirements" section of the proposed revisions applies solely to electronic storage media and micrographic media.
Schwab commends the Commission and its staff for undertaking to expand the Investment Company Act and Investment Advisers Act recordkeeping rules through codifying existing no-action positions and for undertaking actions necessary to comply with ESIGN with respect to electronic records of funds and advisers. We urge the Commission to consider the further clarifications and modifications referenced above in light of its proposal.
If you have questions about this letter, please contact the undersigned at 415-636-1120 or at email@example.com.
CHARLES SCHWAB & CO., INC.
Elaine A. Lindenmayer
Vice President and Deputy General Counsel
cc: Laura Unger, Acting Chairman
Isaac C. Hunt, Jr., Commissioner
Paul R. Carey, Commissioner
Paul F. Roye, Director, Division of Investment Management
Cynthia M. Fornelli, Deputy Director, Division of Investment Management
Robert E. Plaze, Associate Director, Division of Investment Management
Annette Nazareth, Director, Division of Market Regulation
Michael A. Macchiaroli, Associate Director, Division of Market Regulation
|1||CS&Co and CSIM are under common control. CS&Co is registered with the Commission as both a broker-dealer and an investment adviser. Schwab serves 7.6 million active accounts with approximately $800 billion in customer assets. Through its Schwab Institutional Services for Investment Managers enterprise, CS&Co renders brokerage, custody, back office, and related services to over 5700 independent investment advisers whose clients' accounts with Schwab total approximately $230 billion. Schwab is the market leader in providing these services to independent investment advisers. CSIM is registered with the Commission as an investment adviser. CSIM is an investment adviser to the SchwabFunds, a family of over 40 mutual funds, with more than $140 billion in assets under management, which are also registered with the Commission.|
|2||Investment Company Act Release No. IC-24890; Investment Advisers Act Release No. IA-1932 (March 13, 2001) (the "Proposing Release").|
|3||Electronic Signatures in Global and National Commerce Act, Pub. L. No. 106-229, 114 Stat. 464 (2000).|
|4||In the First Call Corporation No-Action Letter (September 6, 1995), the Division of Investment Management stated that it would not recommend enforcement action to the Commission against registered investment advisers that subscribed to on-line services offered by First Call if the research reports made available through these services were maintained by First Call rather than the advisers. Advisers subscribing to First Call's services could view and print accessed on-line research reports but could not download the reports to their own computer systems. Relief was based, in part, on the implementation of certain safeguards by First Call designed to protect the records from loss or destruction and to ensure that they would be accessible to Commission staff. The Commission indicated that it was acceptable if First Call provided former subscribers with requested documents within 48 hours of the time of the request. See also Disclosure Incorporated No-Action Letter (August 22, 1996).|
|5||ESIGN at Section 104(b)(2)(C)(ii)(I) and (II).|