December 9, 1998
Mr. Jonathon G. Katz, Secretary
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549
Re: Books and Records Requirements for Brokers and Dealers
Under the Securities Exchange Act of 1934
Release No. 34-40518
File No. S7-26-98
Dear Mr. Katz:
The Iowa Securities Bureau appreciates the opportunity to favorably comment in support of the above-referenced Books and Records Amendments. As proposed, these rules will facilitate the Bureau performing local examinations, require records that put in place what are essentially the "best practices" many firms already follow, and provide a keystone to protection of customers. These rules are critical to our mission of enforcing Iowa laws prohibiting fraud and dishonest and unethical practices.
The proposed rules have seen a long and difficult history, as recounted in the Commission Release. The rules identify specific, targeted areas that focus on the critical records necessary to monitor and track sales practice abuses. Together with the MOU and the coordination of exams, these rules will provide the maximum efficiency in the use of state and federal resources to protect investors. Subject to two specific preferences (mentioned below) for the original proposal, the Bureau strongly supports the proposed rules. We also encourage the Commission to move swiftly to adopt these provisions. Regulators, the industry, and most of all, investor protection need the certainty and initial finality [ The Bureau still has rules (albeit preempted) on books and records that predate NSMIA, and even predate the Chairmanís 1995 request to NASAA to delay its proposals. The Commissionís rules will result in some unhappiness in all corners. We urge these rules be adopted so that "finality" is reached, with the clear understanding that if one or two elements prove either too weak, or alternatively, too unworkable, the provisions can be fine-tuned with experience.] of adopted rules.
Proposed Rule 17a-3(g)(1) defines "local office" to include locations where two or more associated persons conduct securities business. Iowa would note a strong preference for a one person standard. Oftentimes these are "franchise" or "independent contractor" shops or operate under a "d.b.a." name with insurance, financial planning, tax, or other services. With the absence of an on-site manager, there is often a lack of oversight of these one or two person offices, with the licensees lacking an understanding of some of the fundamental premises of the industry, such as "suitability" or selling away. Requiring core books and records would help provide discipline to these operations, as well as assuring the effectiveness of state examinations and investigations. In a state such as Iowa, where rural communities and county seat towns predominate, these local offices operate quite independently from the home or regional branch office. In recent years, those licensed persons criminally prosecuted in Iowa have typically worked in one or two person offices. Examples include Nicholas Fegen, state prosecuted for unauthorized trading ($2.5 million), Michael Hogan, converted $1.25 million in fake CDs, and Daniel Roepke, unauthorized transactions and conversion of $.9 million. We ask the Commission to reconsider this provision, and restore the one associated person standard. At the very least, we urge no further erosion from a two person standard. For example, in a recent state injunctive/restitution action (the US Attorney subsequently prosecuted the principals) brought by the Bureau against Diacide, Inc., a key salesperson was part of a two-person office. The salesperson was selling away.
The Bureau supports proposed rule 17a-3(a)(6) and (7) which would identify the associated person who is "responsible for the account", and also the identity of any person who has "accepted or entered the order" on behalf of the customer. In a recent major case brought by the Bureau, we encountered the use of joint representative numbers, making difficult the identification of the individual agent who made a specific transaction. In this case, three brokers shared a joint representative number called JB8. The trade confirmations referenced JB8 as the agent who performed a specific transaction. The monthly account statement provided the names of three individuals as the account representative. Only by directly contacting each customer were we able to ascertain more specific information.
Similarly, cold callers hide behind joint rep numbers, negating the ability to use the firm books to track which broker did a specific transaction. Contacting customers to obtain this information is incredibly time-consuming and an inefficient use of agency resources. It is not unusual for a customer victimized by cold calling to not recall the callers name. The business records may be the only source of evidence. In this era of microcap fraud, some firms or branches use unregistered telemarketers, who are often untrained and uneducated. These individuals would be less able to hide from state examiners and firm compliance staff with the implementation of these rules.
We also support the reproposed requirement of time stamping all order tickets. This is critical to any review for possible market manipulation. Other sales practice abuses, such as trading ahead of customer orders, can be found from the "history" of the transactions as they actually occurred. The Bureau could respond more quickly and efficiently with these required records, as opposed to trying to piece together from other sources a string of past events.
We especially endorse proposed rule 17a-3(a)(16), providing for customer account records. The entire relationship between the customer and rep is built upon the information in this document. We question how a rep can analyze or recommend trades to a customer without immediate access to this information. Invariably, when the Bureau brings an agent licensing case, it will contain allegations regarding the lack of suitability of the customer. An increased focus on this area through better recordkeeping can only help firms and regulators ensure greater sensitivity to this fundamental element of investor protection. The requirement of having the investor verify the information decreases the potential use of incorrect or falsified information on the new account form without the investors knowledge. Over the years, the Bureau has received too many complaints where the income or net worth as shown on the new account form (never reviewed by the customer) was completely inaccurate.
The Bureau will support the requirement of an update every 36 months, but would urge the Commission to reconsider its original proposal of annual updates. We think annual updates make good sense in the current economic and social climate where change is the norm. By updating information, the agent can better serve the customer and avoid possible disputes over compliance with the "know your customer" standards. At the very least, we would urge the Commission to monitor this aspect of the rule and seek further data after implementation.
We support the maintenance of customer complaint files as proposed. We believe these would serve as a pointer towards sales practice abuses during an audit, and can only help local managers focus on areas of possible misconduct. By limiting the proposal to keeping written complaints, no new "paper" is being required. We also support the requirement of commission and compensation records for each associated person at a location. In a recent major action filed by the Bureau, the particular firm provided higher compensation for "house stocks" than for agency trades. This factor, plus a lack of trading of other well-known stocks helped demonstrate the sales practice abuses we alleged in our complaint.
We believe that the records required by these proposals will go a long way towards documenting firm compliance in its dealing with investors. The core records required by these rules represent a "best practice" standard, are fundamental to a sound and clean industry, and should not result in substantial additional costs. If anything, with the ever-increasing level of computerization, costs will continue to decrease. The availability of these records also increases state agency efficiency, a critical aspect given the limited regulatory resources that exist on all levels. It also avoids the necessity of taking an enforcement approach to obtain records through subpoenas, which ultimately increases costs (and transfers them to clearing firms, customers, and home offices).
The Bureau strongly supports the proposed rules. Adding these minimal and core requirements will substantially increase the level of investor protection and will strike an appropriate balance between the needs of the states, the Commission, and the industry.
Very truly yours,
CRAIG A. GOETTSCH
Superintendent of Securities