December 7, 1998
Via Overnight Courier
Mr. Jonathan G. Katz
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re: File No. S7-26-98
Books and Records Requirements for Brokers and Dealers Under the
Securities Exchange Act of 1934; Securities Exchange Act Release
Dear Mr. Katz:
On behalf of A.G. Edwards & Sons, Inc. ("A.G. Edwards"), we appreciate the opportunity to comment on the Securities and Exchange Commissions (the "Commission") reproposed amendments to the Books and Records requirements set out in Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934.
In general, A.G. Edwards believes that the reproposing release reflects a more balanced approach to books and records reform than its predecessors. In several key areas, however, the release would impose vastly disproportionate costs and administrative burdens on the securities industry for advancements in sales practice oversight that are either of questionable or marginal benefit, or that can be more effectively addressed by other means.
The industry which is regulated by the reproposed amendments is extremely diverse consisting of major national wirehouses, banking institutions, insurance companies, discount brokers, electronic brokers and small regional and local firms. It is neither possible nor desirable to write a specific detailed set of rules which would govern all facets of the industrys conduct of business. Instead, the Commission should craft the rules so that each individual firm can tailor its individual practices to its business needs yet still conduct business in a way which is consistent with the interests of the public, the firms and valid regulatory concerns.
Unfortunately, while the reproposed amendments are more balanced than predecessor proposals as to books and records reform, these reproposed amendments are still too specific in detail. Tell us what is required - not how to do it.
Consistent with these overall concerns, this letter offers more specific comments on the following issues:
As a threshold matter, in whatever form they are adopted, the rules will require an implementation date that is commensurate with the specific revisions that are enacted. Given the extensive revisions that are likely to be required in firms records creation and retention procedures, and the corresponding need for extensive programming and systems modifications to give effect to these new requirements, A.G. Edwards urges the Commission to establish a reasonable and workable implementation date.
In this regard, it is important to recognize that these amendments are likely to involve significant computer systems modifications for firms at a time when most available resources are being directed at the Year 2000 remediation effort. The Commission has acknowledged the critical nature of the remediation effort by announcing a moratorium on the implementation of new Commission rules that require major reprogramming of computer systems by SEC-regulated entities between June 1, 1999 and March 31, 2000.
In addition, extensive programming requirements associated with "decimalization" will be added in 2000. A.G. Edwards respectfully requests that the Commission make clear in the adopting release that the moratorium will apply to these proposed amendments and that an implementation date sufficiently after July, 2000 be adopted which will permit firms to make the extensive systems changes these reproposed amendments will require.
Each broker-dealer currently maintains extensive books and records relating to all of its operations including those of local offices through the designation of an Office of Supervisory Jurisdiction ("OSJ") for each location where business is conducted. A.G. Edwards believes that the current proposal for recordkeeping and retention at local offices, which would be defined in relation to an arbitrary number of Associated Persons working in a particular location, would contribute little or nothing to the customer protection regime, but would impose significant new costs and substantially disrupt long-established business practices. Neither the state securities regulators nor the SEC has met the burden of demonstrating the need for the proposed "local office" recordkeeping regime, particularly in light of the significant new costs and burdens it would impose.
A.G. Edwards strongly believes that this proposed change is unnecessarily burdensome in light of its purpose, costs and prospective benefits. Importantly, neither state securities regulators nor the Commission has demonstrated pervasive or systematic abuses by the industry in failing to provide access to required records. Even if the premise is accepted that there are instances in which the storage of records in "distant" locations has impeded the speed or efficiency of regulatory inspections or investigations, the desire for more convenient access to such records does not justify a proposed solution of this magnitude. The local office proposal must be balanced against the significant additional recordkeeping obligations that would be imposed on broker-dealers, and the elimination of much-needed discretion of a broker-dealer to bring to the public small, minimally-staffed offices (especially in areas outside of major population centers) without unnecessarily burdensome record retention and maintenance requirements, as is the case under the present regulatory structure.
A.G. Edwards strongly believes that books and records should be maintained in those offices where supervision using those records occurs. Presently, NASD rules require certain records to be accessible at OSJs. A.G. Edwards houses its records at the OSJ. Among other reasons, consolidation and centralization of records is desirable to conserve space, efficiently allocate staff resources, and facilitate internal control. Under the current proposal, recordkeeping would have to be decentralized or records would have to be duplicated for multiple locations. The threat of mishandling of originals in local offices and lack of centralized controls would dissuade many firms from implementing a policy in which the retention of original versions of documents would be decentralized. Consequently, we expect most firms would duplicate all of the required records for all locations. We recognize that the proposal would add a provision in Section 17a-4 that the capability to make documents stored in a form other than hard copy available at a local office within a specified period of time will satisfy the local office record maintenance requirements. While many firms have this capability, use of such technology is not universal within the securities industry and many broker-dealers, particularly smaller broker-dealers, will not be able to rely on this provision.
The costs of defining local office in this manner would be significant. In addition to the costs of duplicating all local office records for the local office and the OSJ, additional storage capacity or facilities may be required. In addition, whenever records are maintained pursuant to rule or regulation, there must be an audit process to assure proper maintenance and a compliance program for assuring ongoing adherence to the record maintenance and retention requirements. The costs related to additional personnel and other resources that would be needed for each local office to establish and maintain a separate record retention and maintenance capability would be prohibitive for many firms. Alternatively, there would be the systems-related costs to provide for electronic storage and retrieval of records in the field.
Rather than basing regulatory requirements on an arbitrary number of individuals, the SEC should be adopting rules that provide flexibility for the offices of the
future. Indeed, given advances in technology, it is not inconceivable that within the next several years, there will be no such thing as a "local office". Firms may conduct business out of "virtual offices" with no defined geographic location. Firms must supervise all of their Associated Persons regardless of location, whether they are conducting business in a city or in cyberspace. The OSJ structure captures all of these locations.
The Commission could achieve its goal of providing certainty as to the location of records along with access to those records while giving firms flexibility by providing the following alternative. The rule should provide that local records be maintained at the office where an Associated Person works unless a firm notifies a particular state in writing that those records will be maintained at the office within the state from which the Associated Person is supervised (the OSJ); or, alternatively, at a single record depository within the state.
In the release the Commission seeks comment on whether state securities regulators should have authority to waive the requirement that a broker-dealer keep local office records at local offices within their respective states. As we have noted before, this would lead to the possibility of 50 different sets of state requirements, and to different requirements for different firms or categories of firms. A.G. Edwards believes this would be an improper delegation of power from the federal government to the states in violation of the National Securities Market Improvement Act of 1996, which prohibits states from implementing individual, and possibly divergent, books and records regulations.
Customer Account Information
The Commission has made a number of changes in the reproposed rules relating to customer account records that address many of the concerns expressed by the industry in response to the original proposal. Nevertheless, the reproposed amendments relating to customer account records still fail to adequately take into account the diverse nature of firms in the industry.
Reproposed Rule 17a-3(a)(16) provides that certain information must be obtained and recorded "(f)or each account that has a natural person as the beneficial owner ...."
This requirement is disconnected from the purpose of the reproposed rule. Under this proposal, the required information would have to be obtained and maintained for the beneficial owners of trusts, partnerships, pension plans, investment companies, limited liability corporations and other types of accounts. This is neither desirable or feasible.
Obtaining the required information serves three purposes: to determine where communications should go; to determine who has authority to transact business with respect to the account; and to determine suitability for the account if the firm is making recommendations with respect to the account. None of these purposes are advanced by requiring information be obtained as to a natural person who is a beneficial owner of an account maintained for a non-natural person.
Reproposed Rule 17a-3(a)(16) should be rewritten to simply require that for accounts other than a single account for a natural person, such information must be obtained to permit the firm to determine: (a) to whom and where communications should be sent; (b) who has authority to transact business on behalf of the account; and (c) the suitability of any recommendation made to the account.
Joint accounts for natural persons must be treated as an "entity" since suitability for a joint account is based on the "entity", not each individual who is a joint owner. The requirement to obtain specific information about each individual beyond that information necessary to determine to whom and where communications are sent, authority to transact business and suitability is immaterial and extremely costly.
In addition, the requirements of Rule 17a-3(a)(16) are not necessarily relevant for accounts introduced and managed by an investment adviser registered pursuant to the Investment Adviser Act of 1940 or by a bank trust department or other fiduciary, or accounts carried by a broker-dealer acting as a clearing broker on a fully-disclosed basis (unless the contract between the introducing broker and the clearing broker provides otherwise), or accounts as to which a broker-dealer neither solicits transactions nor makes recommendations as to securities transactions to the customer.
There are circumstances in which it would be unlikely for broker-dealers to be able to comply with the requirements of proposed Rule 17a-3(a)(16). For example, a broker-dealer that effects transactions for an account managed by an investment adviser or other fiduciary often cannot, as a practical matter, obtain information about the beneficial owner of the account. Fiduciaries acting on behalf of a beneficial owner, such as an investment adviser acting with discretion on behalf of its client, are frequently unwilling to provide the broker-dealer with the name, address or other basic information concerning the beneficial owner, or otherwise to permit the broker-dealer to communicate directly with such beneficial owner. Broker-dealers in these circumstances have no ability to compel the production of such information, and would therefore be unable to comply with the requirements of the proposed rule. We would therefore suggest that, in addition to the exceptions to the proposed rule recommended above, the language of proposed Rule 17a-3(a)(16) be modified to apply to accounts that have natural persons as the legal owner, or owner of record, rather than the beneficial owner.
The alternative updating requirement should not apply when the customer notifies the broker-dealer of a change of address. Customers receive account statements on a regular basis and have ample opportunity to review and make any necessary name and address changes. With respect to these changes, firms generally have standard procedures in place. For good reasons, these procedures do not include sending a copy of the actual new account record. It appears the commission recognizes the risk of sending sensitive information when it asks whether a customers social security number should be included. Anyone seeking to perpetrate a fraud on an account could manipulate this requirement to receive unauthorized comprehensive information on a customer. We suggest that the requirement to send to the customer a copy of the actual new account record to verify a name or address change be eliminated.
The reproposal contemplates that, in some cases, customers will refuse to provide the required information. In such cases, the broker-dealer is relieved of the obligation to obtain the information but the broker-dealer must make a record of the failure to obtain the required information, which record shall contain an explanation of the neglect, inability or refusal of the customer to provide the information. A.G. Edwards requests that the Commission replace the word "explanation" with "notation" so that firms can automate this process by indicating the customers neglect, inability or refusal by checking a box on the new account record. The customers receipt of the new account record is the best evidence that the information was requested. A notation will capture the basic information for regulatory purposes without the significant increase in cost that a separate record would entail.
We do not believe that the benefits to the public and the regulatory purpose justify the extensive cost involved in requiring that specific information be mailed every 36 months to an account that has had no change to the relevant data. We estimate that for our firm alone the cost of doing these annual mailings would be in excess of $700,000.
We believe that these are excessive costs in light of the limited benefits that would be provided to the investing public. The overwhelming majority of broker-dealers and their Associated Persons are in business to provide sound financial advice to their clients based on the clients financial background and investment objectives. Toward this end, relevant information is obtained from the clients and updated and reviewed on a periodic basis to insure proper advice and direction are being adhered to. All that these proposed rules do is add administrative expense and bureaucratic requirements on the vast majority who already have procedures such as these set up between the client and their financial consultant.
Instead, we believe that an annual notice to clients informing them of the importance of providing updated pertinent information regarding changes in their
personal history, financial situation or objectives and investment goals would provide equal or greater benefits and protection to the investor at a fraction of the cost burden to the broker-dealer.
The reproposed amendments also would require a broker-dealer to create a record indicating whether it has complied with applicable securities regulatory authority rules governing the information required when opening or updating a customer account. A.G. Edwards strongly objects to this and other "record of a record" requirements found in the reproposal. Each of these rules are independent regulatory requirements, with which firms must be able independently to demonstrate their compliance. We know of no way to effectively demonstrate compliance with the substantive requirements without producing the actual record reflecting the required information. From a regulatory perspective, a separate record adds very little but, for firms, the administrative burden associated with producing the separate record is significant.
Finally, with respect to the customer account record, A.G. Edwards does not object to the requirement that a record contain the dated signatures of the person grating discretionary authority and the person to whom it is granted so long as it is clear that record can be separate from customer account information. A.G. Edwards believes, however, that this requirement should be drafted in a way that anticipates digital signatures or other comparable technological advances.
The original proposal would have required broker-dealers to produce reports to monitor unusual occurrences in customer accounts such as frequent trading, unusually high commissions or an unusually high number of trade corrections and cancellations. The reproposed amendments would not require broker-dealers to make these types of reports, but instead, would require broker-dealers to retain these reports, if created, or be able to recreate them upon request.
To retain or recreate every report produced would be extremely burdensome given the number and variety of reports that firms employ. A.G. Edwards uses over 1,000 "screens" or "filters" to review trading activity. In addition, much of the review is conducted on-line where the life of the "report" is usually no more than seconds, although it may be as long as one day. The cost of storing the reports or data to reproduce the reports would be prohibitive. An unintended consequence of this requirement would be that firms would produce fewer exception reports.
As an alternative, we suggest that the rule require firms to be able to produce, recreate or to describe how the report was created at a given time and identify the data used to generate the report.
A.G. Edwards is aware of no problems encountered by the regulators in connection with exception reports and therefore we believe the additional alternative places the burden more appropriately on the state securities regulators who are seeking a change to the status quo. Notably, those firms that present the greatest regulatory challenge will simply not produce exception reports.
Reproposed Rules 17a-3(a)(6) and 17(a)(7) require that an order ticket note the identity of any person, other than the Associated Person, who entered or accepted the order on behalf of the customer. As we have suggested before, this provision should be drafted to accommodate the use of data entry clerks by identifying a terminal location rather than an Associated Person. The identity of the person who entered or accepted the order should be based on the terminal ID and the terminal sign-on process. This would be consistent with the NASD Order Audit Trail System ("OATS") rules, which require NASD members to record, at the point an order is received or originated, certain information including the identification of any department or the identification number of any terminal where an order is received directly from a customer.
With respect to commission and compensation records for each Associated Person (reproposed Rule 17a-3(a)(18)), the Commission has provided needed flexibility in how those records are retained. However, the reproposal requires that records be kept for non-monetary as well as monetary compensation. The addition of non-monetary compensation will necessitate costly new systems to track this compensation. We believe instead compensation records should be limited to what is reported on the Associated Persons Form W-2. Regarding each Associated Persons purchase and sale transactions, such information currently resides in firm systems although it may not be available chronologically. Additionally, this record should be keyed to transactions for which the Associated Person was compensated, rather than for which the Associated Person entered the order or was primarily responsible.
Reproposed Rule 17a-3(f) dealing with local offices, however the term is defined, should be limited to local offices within the United States. To extend the requirement to offices outside of the United States would do nothing to advance the objectives of the proposal.
In the 1996 draft amendments, the Commission proposed that all customer complaints, whether written or oral, be retained. Many commenters stated that the meaning of an oral complaint was vague and involved too much uncertainty as to when an oral communications becomes so critical of a broker-dealers practices that it rises to the level at which required records would need to be created and maintained. Whether or not a customer puts a complaint in writing is an important gauge of the seriousness of
the complaint. Requiring oral complaints to be maintained may inadvertently raise some inquiries to a status they do not deserve. Notably, the reproposal will require that broker-dealers retain only written complaints.
A.G. Edwards commends the Commission for acknowledging the difficulty with oral complaints. The reformulation of the provision is consistent with National Association of Securities Dealers, Inc. rules and new Form U-4, which required reporting of written complaints only. Nevertheless, the industry is faced with inconsistent and conflicting regulatory schemes because of a New York Stock Exchange ("NYSE") interpretation indicating that any oral complaint is a complaint reportable under NYSE Rule 351(d). A.G. Edwards believes, in the interest of uniformity, the Commission should direct the NYSE to withdraw this interpretation or, at a minimum, file it as a proposed rule change so that the industry has an opportunity to point out the practical difficulties in a public comment process.
Again, we appreciate the opportunity to comment on the reproposed amendments to the Books and Records requirements set out in Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934.
We thank you for your consideration of these comments. If you have any questions, please do not hesitate to contact me at:
Brian C. Underwood
Senior Vice President - Director of Compliance
A.G. Edwards & Sons, Inc.
One North Jefferson
St. Louis, MO 63103
Phone: (314) 955-3711
Fax: (314) 955-4308
BRIAN C. UNDERWOOD
Senior Vice President - Director of Compliance