Speech by SEC Staff:
Remarks at Books and Records Compliance Countdown
Mary Ann Gadziala
Associate Director, Securities and Exchange Commission
March 24, 2003
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author's colleagues upon the staff of the Commission.
I am pleased to be here to open this session of the Books and Records Compliance Countdown. Since you spent the morning exploring the legal and technical requirements of the rule, I would like to focus on the practical aspects from the view of supervisors, compliance personnel, and examiners.
As mentioned in the introduction, I am an Associate Director in the SEC's Office of Compliance Inspections and Examinations and lead the broker-dealer examination program. My group looks to the books and records rule to provide important tools for effective supervision, compliance, and audit capabilities - those tools include accurate and complete books and records. Examiners and compliance personnel are not present to watch every transaction take place or to listen to what a registered representative may tell a customer. They have no choice but to examine the story that is told by your books and records. Therefore, it is necessary that your books and records be made available promptly to examiners and that they are accurate and complete records of your business activities.
While accurate and complete books and records are key to our work as regulatory examiners, this is not their only purpose. They are also essential tools for the management of risks and supervision of activities in your firms. In addition, they are required to protect investors and maintain good business relationships by recording the understandings between you and your customers. If disputes arise, books and records provide the necessary proof of what actually transpired.
In my remarks this afternoon, I shall focus on the importance of books and records in two areas - first, within the overall examination process - and second, with respect to a focus on specific types of examinations where compliance with books and records requirements is particularly pertinent.
The Examination Process
The effectiveness of the examination process is highly dependent upon the prompt production of accurate and complete books and records. We typically start our exams with an initial document request letter for policies and procedures and request lists of activities, accounts, or transactions. We expect these general documents to be provided to us within two weeks. Based upon the response, we will then request that particular information be made available upon our arrival at the firm. This may include account information, exceptions, complaint files, or other information related to particular business activities. Once we arrive at the firm and begin interviewing firm personnel and reviewing records, additional questions arise and other related books and records may be requested. This is often necessary to get a full picture of the areas we are examining. Some examinations are conducted without the preliminary letter and notice. That is, the examination begins with the arrival of examiners at the firm and the request for document production on-site. In all cases we expect firms to comply fully with the requirements of Section 17(a) of the Exchange Act and Rules 17a-3 and 4. Therefore, records must be made and preserved for the requisite time periods, and firms must "furnish promptly ... legible, true, complete and current copies" of all books and records to regulatory examiners as requested.
What are some of the important practical points associated with on-site exams?
First, what does prompt records production mean? It means that information requested by examiners on-site should generally be produced on the day requested; however, if information requested is unusually voluminous or complex, firms should discuss with the examiner a mutually agreeable time-frame for production of the documents.
Second, all records of the firm are covered - not just those specifically required by rule to be made and kept, but all records; this would include exception reports and any other firm records regardless of whether they are required by rule to be created.
Third, electronic messages, including internal and external business-related emails must be kept and produced when requested by examiners.
Fourth, while firms may keep records electronically rather than in hard copy, the records must be non-erasable, non-rewriteable, organized, and immediately produced or reproduced. (Rule 17a-4(f)).
Fifth, the records must be kept for the requisite period of time, typically three or six years, as specified by rule depending on the type of information; it is not sufficient for example to keep records of emails for a number of months or a year and then re-use or write over the tapes.
The law requires that accurate and complete books and records be provided promptly to examiners. Failure to do so may result in a deficiency letter or, in egregious cases, in an enforcement referral and sanction. While this may be sufficient incentive, there are other reasons to do so. Exams will be completed more expeditiously and efficiently and you can return your full attention to other business matters. The exams will be more effective and may provide you with helpful insights on improvements you may make to your compliance systems. Keeping full and accurate books and records will also allow you to supervise effectively your own business and stop aberrant behavior that might cause financial or reputational damage to your firm. And books and records also serve as your documentation in any controversy over business activities or transactions.
I would like to now turn to some of the specific types of examinations that we conduct where the prompt production of full and accurate books and records are particularly important. The first such examination is, of course, our "Books and Records" examination. This is an examination focused on compliance with the books and records rules rather than on compliance with other financial or sales practice requirements. Therefore, it is the most relevant to the specific technical requirements of the rule. Once the amended rule is effective on May 2, we expect to conduct a number of these focused examinations for compliance with the requirements. One area where we have seen a number of problems is the retention of emails for the prescribed periods and I expect this will be a particular focus.
Another type of examination where the books and records rule is key is the comprehensive compliance examination. This examination covers enterprise-wide compliance - all the broker dealers within an organization and all their compliance responsibilities. We conduct a top-down evaluation looking at management oversight, sufficiency of resources, independence and experience of compliance personnel, surveillance and exception reports, business and branch supervision, customer and account information, audit trails of orders and executions, tracking and resolution of problems, and the overall compliance culture. Some of the new requirements and clarifications with respect to making and keeping books and records relating to order tickets, customer accounts, exception reports, and new and old compliance manuals will be particularly useful in conducting these examinations. In addition, the requirement that firms identify persons who can explain how the firm makes, keeps, and organizes records is important to the effectiveness of the compliance examination.
Branch office examinations are another area where these new books and records requirements should be particularly helpful. There are approximately 90,000 branch offices of broker-dealers nationwide, and we and the SROs have been able to examine only a small percentage of them in the past. However, with additional resources, we expect to increase substantially the number of branch office examinations that we conduct. The state securities regulators also conduct many examinations of branch offices. Compliance with the new books and records rules requiring that particular records be kept at or promptly produced at each local office will make this process much more effective and efficient for all of us.
There are also many cases where better books and records might have exonerated a firm or registered rep or prevented customer confusion or dissatisfaction. For example, in some recent cases involving the misappropriation of customer funds, firms and customers would both have been better served if the firm had better records and systems for supervising and verifying addresses, account statements, and fund transfers and withdrawals. Requirements to address these issues are found in the new rules. During our recent mutual fund breakpoint examination sweep, we found that nearly one in three transactions in front-end load mutual funds that appeared to be eligible for a breakpoint discount did not receive one. Much of the problem resulted from firms' failure to have and use the proper records of customers' ownership of different funds in the same family or purchases by related persons. There was also a failure to disclose breakpoint opportunities to customers in writing or to keep records of any oral disclosures made. Had better records been made and kept, I expect there would have been far fewer problems in this area. There have also been examples where the failure to get full customer or transactional information resulted in problems related to money laundering and the antifraud laws. Not only does this result in substantial financial risks but costly reputational risks as well.
In conclusion, books and records may seem mundane, but they are useful, even essential in assuring effective and efficient compliance. I hope that you all will view the books and records rules, not as burdensome technical requirements, but rather as critical tools that assist in compliance and supervision and ultimately in protecting investors and ensuring the financial stability of your firms and the U.S. capital markets.