December 7, 1998
Mr. Jonathan G. Katz
United States Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Re: File No. S7-27-96
Proposed amendments to Rules 17a-3 and 17a-4
Dear Mr. Katz:
The International Association for Financial Planning (IAFP) is pleased to provide these comments on the reproposed revisions to the books and records requirements of Rules 17a-3 and 17a-4. IAFP is the largest and oldest membership association representing the financial planning community. We have over 120 NASD-registered broker-dealers that are members of our Broker-dealer Division. Collectively, these firms have over 100,000 representatives affiliated with them. The majority of our over 17,000 individual members are registered representatives of broker-dealers and thus will be significantly affected by the reproposed revisions to the books and records requirements.
IAFP and its members support attempts to increase investor protection and confidence in the securities markets. We recognize the examination process is an important element in protecting the public. We also understand regulatory agencies must have timely access to useful information to determine if broker-dealers follow applicable rules and regulations.
The books and records requirements of Rules 17a-3 and 17a-4 have continually been expanded and refined over the years to meet the challenges of an ever-changing securities industry. We believe the current rules have achieved a careful balance between the needs of the regulatory authorities for access to necessary information, and the economic and administrative burdens imposed on the industry.
We find the initial and reproposed revisions to the rules to be unnecessary. The Securities and Exchange Commission (the Commission) has not provided any information that would indicate current rules are inadequate in protecting consumers. To the contrary, it appears the current rules provide a high degree of information that is satisfactory to the Commission and the National Association of Securities Dealers (NASD). If both the Commission and the NASD provide no evidence the current books and records requirements are inadequate, we believe state regulatory authorities also should find these requirements satisfactory to meet their needs. Broker-dealers who fail to cooperate with state regulatory authorities' requests for information are already subject to loss of their state registration. This is a powerful incentive for broker-dealers to promptly respond to requests for information or documents.
We are pleased the Commission considered some of the issues we raised concerning the revisions it proposed in 1996. However, the reproposed revisions still do not address some of our original concerns and also raise new ones. The reproposed revisions do not adequately consider the enormous economic and administrative impact on the securities industry and fail to promote increased investor protection.
We strongly request the Commission greatly limit the scope of these reproposed revisions. The negative impact the reproposed revisions would place on the industry (and ultimately, the investing public) is simply too great when compared to the modest benefits state regulatory authorities would receive. Following are our specific comments on the most troubling aspects of the reproposed revisions.
Marking Order Tickets
The reproposed revisions would require an order ticket to identify the associated person who entered the order and would further require that an order ticket contain the identity of any person, other than the associated person, who entered or accepted the order on behalf of a customer. The reason cited for the requirement is to permit securities examiners to determine whether particular persons, including unregistered persons, are engaged in sales practice violations.
We believe that the addition of the identity of any person, who accepted the order, if different than the person entering the order, would provide no useful purpose. The person handling the account is responsible for acceptance and entry of orders on behalf of the customer. If the person handling the account permits another person to accept or enter the order, he or she should still be the responsible party. If the person handling the account permitted unregistered persons to accept orders, this would clearly be an intent to violate the rules and firm policy. In all likelihood, such a person would not voluntarily record the name of the unlicensed individual on the order ticket to document the violation.
Customer Account Records Necessity
Our members also voiced considerable objection to the reproposed requirements regarding "records of each account of a customer." Under rules of the NASD and other SROs, broker-dealers are required to maintain specified information regarding their customers. See e.g., NASD Rule 3110 and IM-3110. Broker-dealers and associated persons must also have reasonable grounds for believing that each transaction is suitable for their customers. This suitability obligation often requires the broker-dealer to obtain information in addition to that currently required to be included on the record of each account of a customer.
However, there is no present requirement that all of this basic account information must be contained in any one document. Quite often, this information is collected at different times, based on the nature of the transactions in which the customer is engaging. For example, an associated person might fill out a basic account form for a client who is performing an initial transaction, and then later obtain much more extensive information about the customer during other types of transactions. Requiring the associated person to obtain all of this information at the outset may be completely unnecessary if the client does not transact further business. Moreover, requiring all of this information to be included on a single form will impose substantial administrative burdens on broker-dealers, without increasing customer protection. We do not see any benefit of requiring customer information to be included on a single form.
Customer Account Records Updating Frequency
The reproposed revisions adopt a specific deadline of at least every 36 months for periodic updating of the record of each account of a customer (record). We believe if the client's record has no changes to their contact information or investment objectives and the client does not enter into any additional transactions, there should be no requirement to update forms. Thus, if an existing client never enters into another transaction with the broker-dealer, no updating of the record should be required. We suggest the Commission amend the reproposed revisions so that if an existing client wishes to engage in a new transaction, an updated record would be required only if their prior record is more than three years old at that time.
IAFP members conduct the majority of their business in professionally managed packaged products such as mutual funds and variable annuities, which by their very nature are long term investments. As a result, most of their investors' investment objectives do not change frequently. Of course, under the general suitability requirements, an associated person is still obligated to confirm that a particular investment meets an investor's objectives at the time of each transaction, and if the associated person learns the customer's objectives have changed, the associated person will be required to update the account form. We object however, to a mandatory requirement to update all account forms at a fixed time.
Local Office Definition
Of all of the reproposed revisions, we find the requirements relating to maintenance of records in "local offices" to be among the most onerous and pointless in increasing protection for the public. Most of our members utilize the remote office structure. They are able to provide a very effective and efficient means of supervising their associated person's activities through the use of centralized operations (in which the compliance and back office personnel are situated in the same location with the firm's records), periodic on-site inspections of their remote locations, and other compliance procedures. Centralized operations provide greater efficiency and substantial cost savings. This saving is passed on to the client and encourages competition that directly benefits the investing public.
The reproposed revisions would define "local office" to include locations where two or more associated persons regularly conduct securities business. This definition is far too narrow, does not consider the nature of the duties carried out in what the proposal defines as a local office, and infringes upon the supervisory structure currently used by the National Association of Securities Dealers (NASD). The number of people in an office does not indicate the amount of business or activities taking place in a remote location. The NASD's OSJ system and the proposed new structure are not designed to complement each other. This will only increase costs due to duplication of records between remote locations and OSJs.
We suggest the Commission abandon the concept of local office and allow the NASD's current definition of Office of Supervisory Jurisdiction (OSJ) to remain intact. OSJs maintain and provide access to all the necessary information and records. The NASD's definition of an OSJ is as follows:
(3) The designation as an office of supervisory jurisdiction (OSJ) of each location that meets the definition contained in paragraph (g) of this Rule. Each member shall also designate such other OSJs as it determines to be necessary in order to supervise its registered representatives and associated persons in accordance with the standards set forth in this Rule, taking into consideration the following factors:
(A) whether registered persons at the location engage in retail sales or other activities involving regular contact with public customers;
(B) Whether a substantial number of registered persons conduct securities activities at, or are otherwise supervised from, such location;
(C) whether the location is geographically distant from another OSJ of the firm;
(D) whether the members registered persons are geographically dispersed; and
(E) whether the securities activities at such location are diverse and/or complex.
This gives the broker-dealer flexibility in structuring its compliance program and ensures sufficient information will be available for regulatory inspections.
Local Office Record Requirements
The reproposed revisions would still require voluminous duplicate records to be kept in small offices (those of two or more individuals) and would greatly increase the costs of operations. These costs would, out of necessity, be passed to the firms' clients. The reproposed revisions would not however, enhance the firm's supervisory systems. The reproposed revisions will simply relocate the place in which broker- dealers keep records.
We are also concerned that many firms, especially those located in smaller communities, cannot afford the costs of implementing these procedures or would not be able to recover enough of these costs to remain in business. The loss of these firms would seriously diminish the ability of investors in these smaller communities to have access to quality financial planning advice and the capital markets, and would greatly lessen competition.
We cannot agree that the solution to the relatively infrequent problem of broker-dealers not promptly providing information requested by the state regulators is for every broker-dealer in the country to be forced to keep voluminous and confidential records at thousands of remote locations even for one year.
Keeping records at the OSJ level would not prevent any state regulatory authorityies from examining any broker-dealer location in theirits state. The states would be free to conduct surprise or other examinations of each office in their state. The only limitation will be, where advance notice is not provided, state regulatory authorities will have to allot additional time to provide the examiner with the appropriate documents if the regulator is examining any office other than a home office or an OSJ.
We believe the minimal additional time required for regulators will not negatively affect investor protection. The vast majority of broker-dealers fully cooperate with regulators and promptly provide requested information and documents. The additional time required for regulators is far more reasonable than requiring an entire industry to keep tens of thousands of small offices constantly filled with duplicative documents in anticipation of an examination.
Records Retention Requirements and Periods.
Our members are opposed to any increase in the types and periods of time during which documents and records must be retained. We have addressed above our opposition to many new types of documents that the Commission has proposed that broker-dealers maintain. Even for currently required documents, their retention period should not be increased, nor should the categories of documents that must be "easily accessible" be increased. It is not cost-effective for our members to keep long lists of documents in very expensive office space simply so they can be produced in a very short period of time. The current rules should be retained, as the reproposed revisions would not improve investor protection but will dramatically increase industry cost. As stated above, we believe the shortest period of time the Commission should require broker-dealers to furnish on-site documents is 24 hours.
We also suggest the Commission remove the requirement of naming any principals responsible for establishing policies and procedures. This is already maintained in each firm's compliance manual as required by the NASD Rule 3010, making the reproposed revisions duplicative. Rule 3010 requires broker- dealers to designate an appropriately registered principal(s) with authority to carry out the supervisory responsibilities of the member for each type of business in which it engages for which registration as a broker- dealer is required.
Local Office Record Request Response Times
We suggest the Commission address the problem of timely access to necessary documents by requiring broker-dealers to "promptly" provide the requested information. The Commission should require broker-dealers to provide "promptly" upon request any information or documents specified in the rules regarding a firm's business, whether at the home office, an OSJ, or a remote location. The term "promptly" should be defined as requiring the requested information or document to be produced within 24 hours for information or documents that happen to be located at the site where the examiner is located, or within 5 business days for all other information or documents.
The reproposed revisions require offices where the inspection is conducted to produce documents immediately when the request is made. Fulfilling a regulator's request often requires substantial time to produce and organize documents or information, particularly in the case of small broker-dealers where only one person may be able to access information quickly. If that person happens to be unavailable, it may take until the next day for other personnel to locate even on-site information or documents. Immediately or the "same" day is not enough time in many instances.
The reproposed revisions also define promptly as producing within three business days those records not kept at the local office. Documents located off-site require more time to produce. The location of the documents must be determined (since firms may have several off-site records storage facilities), the appropriate storage site must be contacted, the documents must be retrieved from the storage facility and prepared for shipping (which often takes a full day or more), the documents must be shipped to the examination site, and the documents must be organized for presentation to the examiner. In many situations, this process will take several days; therefore, we do not believe 5 business days is an unreasonable amount of time to accomplish these steps.
IAFP and its members believe there should be no requirement for any account or other information or documents to be located at any site other than the broker-dealer's home office (or other office designated as its document depository) or an OSJ. If the Commission adopts our recommended record retention method, state regulators will have prompt access to records without imposing costly and logistically cumbersome in-state depositories requirements on broker-dealers and their registered representatives. Regulatory authorities wishing to examine remote locations could retrieve promptly or request in advance information or documents they wish to examine while at the remote location from the home office or an OSJ.
Client Communications Requirements
The requirements of maintaining "client communications" are much broader than the NASD's current requirements, NASD Rules 2210(b) and 3010(d), regarding retention of advertising, sales literature, and correspondence pertaining to the solicitation or execution of a securities transaction. The administrative and economic burden of retaining and organizing every communication to a client, as well as all inter-office memoranda, is simply unnecessary and will not increase consumer protection. Any relevant information that a state regulator would need would be available in the documents required to be maintained by the aforesaid rules.
Inaccurate Estimation of Costs
The Commission's Release contains a discussion of the estimated costs attributable to the reproposed revisions. Our members believe these costs are grossly understated. Major revisions would be required to be made in firms' account information, computer records systems, compliance systems, records storage systems, and account review systems.
The estimation of costs also ignores that complying with these requirements is very labor intensive. Many of these costs will be on-going, particularly costs relating to updating client account information, expanding remote locations to provide adequate space for required records, and additional periodic updating of client computer information. These costs either were not considered in the estimate, or inaccurately estimated. For a number of broker-dealers, the costs will make expanding or even maintaining current business extremely prohibitive.
Year 2000 Compliance
We believe the Commission is not fully considering its own moratorium on new rules in order for NASD members to focus on implementing computer systems that are Year 2000 Compliant. Implementing any new rules related to customer accounts and remote office records will require an enormous amount of time for new programming. We suggest the Commission withdraw these rules, in addition to the above reasons, due to the Year 2000 moratorium.
Our members believe the current rules have achieved a reasonable balance between protection of investors and the economic and administrative burdens on the industry. The reproposed revisions would greatly disrupt this balance, placing a far greater burden on the industry without any corresponding increase in protection for the investing public. We respectfully request that the Commission limit the reproposed revisions of Rule 17a-3 and Rule 17a-4 to those we have suggested above.
IAFP wishes to thank the Commission for its consideration of these comments. If the Commission has questions regarding these comments, or would like further information, please contact me at the address shown above or at (404) 845-0011, extension 7764.
Dale E. Brown, CAE
Associate Executive Director