July 14, 1999Jonathan G. Katz
CS&Co. is a registered transfer agent with respect to the 48 Schwab proprietary mutual funds. CS&Co. is also a registered broker-dealer with the second largest number of active brokerage accounts of any broker-dealer in the United States.
As both a registered transfer agent and broker-dealer, we applaud the Commission's recognition of the electronic revolution in the financial services area and its willingness to attempt to accommodate electronic methods of doing business under the Securities Exchange Act of 1934. In particular, we strongly believe that the same rules for storage of required books and records should apply both to broker-dealers and transfer agents. Otherwise, firms such as Schwab that are registered both as broker-dealers and as transfer agents will be subject to costly differences in recordkeeping obligations without any corresponding benefit to investor protection. We also strongly support the concept of electronic record retention for both broker-dealers and transfer agents: electronic storage is potentially both less expensive for firms and more accessible for regulators than paper, microfilm or microfiche-based storage.
However, before we address the Commission's proposal in detail, we would like to raise an overarching concern with the Commission's approach towards electronic storage. Specifically, Rule 17a-4 and the proposed amendments require that any electronic storage media used must preserve records in a format that is "not rewriteable and not eraseable," a standard generally referred to in the industry as "WORM" storage. (WORM is an acronym for "write once read many.") We understand and support the Commission's apparent objective, which is to ensure reliable record maintenance. However, the need for reliable long-term electronic storage is common in the information technology industry, and rarely if ever have experts outside the securities industry settled on WORM technology as the only acceptable approach. In our experience, WORM technology is much more expensive than other electronic storage methods, and, even more importantly, at this time it is not scalable to record large amounts of data. Moreover, the information technology industry has identified other storage methods as sufficient to maintain the authenticity and reliability of electronic data. For example, we understand that an electronic storage system which allows read-only access to all but a carefully controlled number of system administrators, together with an audit system to identify changes made to records required to be retained, is generally viewed as adequate in the information technology industry. Indeed, we understand that many broker-dealers which rely on electronic records in their day-to-day operations currently print out and store paper records to satisfy their Rule 17a-4 obligations because they find the WORM electronic storage requirements to be unmanageable.
We are concerned that by specifying the particular requirements and compliance methods that electronic storage technology must meet to be considered adequate under the rules, the Commission is creating a more burdensome standard for electronic storage than for other kinds of storage media. We are also concerned that with the rapid evolution of technology, such a detailed framework will quickly become obsolete (if it is not already obsolete), and could discourage the development and use of other types of storage technologies that might otherwise provide adequate protection of and access to records. The Commission has not applied such a standard to records retained on paper or on any other medium.
Accordingly, we believe that the Commission should consider a more goal-oriented approach to the recordkeeping rules - for both broker-dealers and transfer agents - that does not specify a particular technology for electronic storage, but instead identifies standards with which all storage media, electronic or otherwise, must comply. Such an approach would satisfy the Commission's goal of ensuring the safekeeping of records, and would provide an incentive to develop new document storage techniques by ensuring a level playing field for all types of storage media.
Consistent with this broad concern, we also have specific comments on the proposal. In particular, the proposal would require transfer agents using electronic storage media to designate "at least one party other than the transfer agent" that would file representations with the Commission stating the party's ability to download information from the transfer agent's electronic storage system, and agreeing to provide this information to the Commission upon request. The proposal suggests that this party would be the transfer agent's electronic storage media vendor. Large firms such as Schwab may choose to provide electronic storage in-house, and do not necessarily need the services of a third party to make available such facilities. Requiring firms that have this internal capacity to contract with a third party solely to comply with this provision is unnecessary and expensive. We would therefore recommend that the Commission amend the proposal to remove this requirement for those transfer agents that maintain their own electronic storage facilities.
In addition, in the interests of consistent broker-dealer and transfer agent rules, we recommend a technical change to conform the proposal with Rule 17a-4. Specifically, Rule 17a-4(f)(3)(vii) states that for every broker-dealer "exclusively using electronic storage media for some or all of its record preservation," at least one third party must have access and the ability to download the information and must undertake to provide this information to the Commission upon request (emphasis added). Proposed Rule 17Ad-7(f)(5) contains language that is similar to that of Rule 17a-4(f)(3)(vii), but omits the word "exclusively." This omission would result in transfer agents being required to designate this third party to provide the records, even if the transfer agent uses an additional storage method to keep records under the rule. We would therefore recommend that the proposal be amended to conform with Rule 17a-4.
Again, we appreciate the opportunity to comment on the Commission's proposal. Please do not hesitate to contact the undersigned at (415) 636-1093 should you have any questions.
W. Hardy Callcott
Senior Vice President and General Counsel
Charles Schwab & Co., Inc.