December 9, 1998 Jonathan G. Katz Secretary Securities & Exchange Commission 450 Fifth Street NW Mail Stop 6-9 Washington, D.C. 20549 Re: File No. S7-26-98 Books and Records Requirements for Brokers and Dealers Dear Secretary Katz: The State of Oregon wishes to offer the following comments in support of the reproposed amendments to Rules 17a-3 and a-4 of the Securities Exchange Act of 1934. A. Background on Oregon*s Examination Process - Our two primary examiners both came from the brokerage industry. One worked as a registered representative for a major brokerage firm (A.G. Edwards) for seven years. The other worked in the back office of a regional brokerage firm (Dain Bosworth) for 10 years. In the five years they have been with our office, this team has developed an examination module that allows them to thoroughly review an office for sales and supervision problems, with minimum down-time to the firm being examined. While our examiners conduct *for cause* exams based on complaints received, we will focus our comments on the need for books and records for routine exams. In the more than 20 unannounced routine exams our examiners have conducted in 1998, we found very few egregious deficiencies. However, at every office we found evidence of inadequate supervision and deficiencies in compliance with our rules and with the rules of the NASD and other SROs. Our examiners have developed an exam module that allows branch office exams in 1-2 days for small to medium size firms; and 2-4 days for larger firms. They have designed a document request list for office branch examinations. For smaller firms, they arrive unannounced. For larger firms, they fax the document request list one day before an office exam is set to begin. They have found with the larger firms that a one-day notice will make the exam run more efficiently, while still allowing for the element of surprise. B. Specific Books and Records Used as Examination Tools As mentioned above, both of our examiners come from the industry -- one as a broker and one from the back office. They have an understanding of what books and records can be the most efficient tools with which to uncover sales and supervision problems. Four of the most useful tools are described below: Correspondence - A file of all correspondence (both incoming and outgoing) must be maintained at the local level. We have found an audit of the correspondence files to be one of our best examination tools. We have found many items in the correspondence files that should be kept elsewhere (signed legal documents, letters of authorization, mutual fund switch letters, etc.). This review allows us to call this deficiency to the attention of the branch manager, and also serves as an indicator of how closely that branch is being supervised. Order ticket information - The order ticket information is critical if the examiner is to look for *best execution* and sales abuses. The data necessary includes the date and time stamp, entry ID information, and mark-up or mark-down data. In addition, the examiners need to look at cancel and re-bill files to uncover any trading corrections and to determine how the accounting was handled for any errors. Customer Account Records - Oregon has several concerns about the trend towards electronic Customer Account Records. These forms contain information about clients* net worth, investment goals, risk tolerance and investment experience. These forms must be maintained in a hard copy format in order for customers to acknowledge the accuracy of the information. These forms are important for several reasons: (1) The Customer Account Records will be used years later as evidence in suitability claims. We receive and investigate numerous complaints every year related to suitability and the first document we request is the Customer Account Record. If firms routinely maintain these records with proper acknowledgement by the client, they will reduce their risk of losing suitability claims and substantially reduce the time it takes to investigate those claims. (2) The Customer Account Records are randomly reviewed in routine exams to make sure that trading activity is consistent with the customer*s objectives, net worth and investment knowledge. (3) Customer Account Records need to be routinely updated. Another problem our examiners have seen is a failure by the branches to periodically update the information on the new account forms. They have seen customer accounts opened 20 years ago where the broker has not updated the customer*s information related to net worth or investment objectives. If these forms are kept only electronically, the risk arises that a broker could go into the computer and change the client data without an audit trail. We recognize certain advantages to maintaining this information electronically. (For example, sophisticated compliance software will allow firms to block any trades inconsistent with data in the Customer Account Record.) However, if account records are to be maintained in electronic form, we strongly support a requirement that any changes be printed out and sent to the customer for verification. Commission Runs - A review of the commission runs offers the regulator a number of insights into the operations of a branch office. Commission runs show the regulator who the big producers are in an office. Annual commission runs are used to look at trends and to spot any abnormalities. If a particular broker*s commissions went up significantly one month, or if the product mix changed drastically, the examiners will then go back to the monthly commission runs and, if necessary, to specific days. The examiners will also look at trading patterns for the beginning and ending of the commission period. They have found that brokers who churn will often do so at the beginning of the month to start out the month with a big trading day, or at the end of the commission period. A commission-driven business will no doubt show a strong push for sales at the end of the month. Those sales may be entirely suitable but this can only be determined by a review of the Customer Account Records and other books and records maintained at the office. Commission runs also give examiners a picture of the product mix of the branch. This is helpful in understanding what kind of business the broker is doing and if the office has had a sales contest or additional mark-up on a particular product. Commission runs are already maintained at branch offices and kept by individual brokers because their yearly bonuses are usually tied to their profitability to the office. C. Definition of Local Office Oregon supports the re-proposed definition of *local office.* Although we would prefer that *local office* include offices with one licensed person, we can agree to the re-proposal as long as it also includes the requirement that one-person offices maintain records in a depository located within our state. For example, the broker E.D. Jones maintains 81 branch offices in Oregon with only one licensed representative. We will no longer be able to conduct unannounced exams at those sites since the records will not be located at the sites. But we can agree to this proposal of maintaining those records in an off-site depository, as long as the site is located within our state so we have jurisdiction to obtain those records. In closing, we would like to emphasize our belief and experience that the books and records that would be required under the re-proposed rules are the same information that branch office managers themselves need to adequately supervise their operations. Our examiners have found that by assisting branch managers in uncovering areas of inadequate supervision, they are helping them to do a better job of supervision. Our routine exams serve mostly to uncover inadequate supervision and to detect problems before they arise. Sincerely, Lisa Nuss Acting Chief of Registration and Licensing (503) 947-7854 ! ! ! !