December 9, 1998
Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 6-9
Washington, D.C. 20549
Re: Proposed amendments to Rules 17a-3 and 17a-4 under the Securities and Exchange Act of 1934.
Your File No. S7-26-98
Dear Mr. Katz:
Thank you for the opportunity to provide input on the above referenced, proposed rule. We applaud the tireless efforts of the Securities and Exchange Commission (the Commission) in its attempt to construct a rule designed to clarify recordkeeping requirements and assist securities regulators when conducting sales practice examinations.
The firms joining on this letter, Ameritrade (Inc.), Charles Schwab & Co., Inc., Discover Brokerage Direct, Inc., DLJdirect Inc., Datek Online Brokerage Services Corp., E*TRADE Securities, Inc. and Waterhouse Securities, Inc. ("the Firms") maintain a total of over 9,692,701 customer accounts, providing public customers with the ability to enter, both online and via other media, unsolicited orders in equities, bonds and mutual funds. We believe that the Firms are in a position to provide unique perspective into the practical effects that the rule would have if enacted in its current form.
There are several requirements contained in the rule which may have positive consequences if applied to traditional full service broker-dealers, but which are impractical and without positive effects as applied to the extent a broker-dealer accepts unsolicited orders (so called discount brokers, hereinafter referred to as "unsolicited brokers"). 1
One such requirement is contained in proposed section 17a-3(a)(6). That section requires that the broker-dealer create a memorandum of each brokerage order given or received for the purchase or sale of securities. Among other things, the proposed rule states that the memorandum must contain "the time the order was received" and "the identity of each associated person responsible for the account and any other person who entered or accepted the order on behalf of the customer." These sections simply do not apply to an unsolicited broker and their enforcement in that context would add no value. As we will describe, in the current environment, the records that should be required are already retained by the Firms and those that would be impractical to create are not.
Generally, unsolicited brokers may never meet their customers in person. Their customers usually open accounts by delivering account opening documents to the unsolicited broker . Unsolicited brokers, ordinarily, do not assign specific representatives to specific accounts. Customers can enter orders with an unsolicited broker by either calling a telephone number and speaking to the randomly assigned registered person for that call or by entering the order online via their home computer or through interactive voice response technology directly into the broker’s system. 2 No associated person is assigned to an order received online and, since no associated person ever handles the order, no record could be created which captures such information. For these reasons, we ask that an exemption to the requirement regarding the identity of the associated person assigned to the account or who entered or accepted the order be created for orders received online or by other automated means or that some other clarifying reference be made.
All orders, no matter how they are received, are entered (sent to the market) virtually immediately. While the time of receipt and time of entry of online orders are recorded and retained systematically, no record of time of receipt is created for orders received by telephone. Because the average time elapsed between time of receipt of an order by a representative and time of entry by that representative is a matter of seconds, such a record would not add any value. In fact, its creation would only delay what is a very fast process. A registered person at an unsolicited broker who receives an order by telephone, who ordinarily enters the order simultaneously with its receipt, would now be required to first enter the time that the customer stated the order and then enter the order. A process that is designed to get customer orders to market as quickly as possible would be delayed for no reason at all. Aside from the damage it would do to the process, the cost of the programming change that would capture time of receipt is not justified by the value of having the information. Such a record in the context of the unsolicited broker would serve no legitimate purpose. For these reasons, we ask that an exemption to the requirement regarding the time an order is received be created for unsolicited brokers or in the alternative that the time of order receipt be required to be recorded and retained only where that time is not substantially simultaneous with the time of order entry.
1. Obtaining Suitability Information
A broker-dealer is an unsolicited broker, by definition, to the extent that they do not make recommendations to customers. Accordingly, they do not recommend specific securities, types or classes of securities, or investment strategies. Unsolicited brokers do not assess the suitability of non-recommended customer orders. While unsolicited brokers today provide more information and other services for the use of their customers than ever before, that does not change their essential function: they accept orders from customers and execute them.
The rules of the self-regulatory organizations require that broker-dealers obtain (among other information) a customer’s investment objectives and risk tolerance before recommending a security to that customer. If a broker-dealer does not make a recommendation to a customer, it need not obtain this information (other than for customers trading in options). For these reasons, many unsolicited brokers do not require that their customers provide this information when the broker has not made a recommendation. Because it need not expend the resources to obtain and evaluate this information on a trade-by-trade basis, unsolicited brokers are able to handle more orders and, therefore, charge a discounted commission for those orders. If the Commission mandates that unsolicited brokers obtain that information (unless the broker is asked to then ignore it), it will virtually eliminate the role of the unsolicited broker as it currently exists. All brokers will need to either expend the resources -- in the form of increased staffing and training -- to obtain and evaluate each customer’s investment objectives and risk tolerance or reduce the amount of orders it accepts. Either way, and at a minimum, the new rule would disproportionately impact unsolicited brokers.
In addition, it is widely understood that unsolicited brokers generally make no determination as to the suitability of any customer order for accounts where the broker makes no recommendation. This is acknowledged by customers of unsolicited brokers in their agreements with unsolicited brokers and self-regulatory organizations and state regulators alike recognize the distinction. Some customers who use the services of unsolicited brokers do not expect or want such advice. These customers choose an unsolicited broker knowing that, and often because, they prefer to make their own investment decisions. If unsolicited brokers must obtain the information upon which a determination of suitability is made (investment objectives and risk tolerance) it could create the false expectation by these customers that such a determination is, in fact, being made.
For these reasons, we ask that the section regarding the suitability information on the record of account include an exemption for unsolicited brokers where they do not recommend transactions for the customer. In the alternative, the rule must include some statement as to what an unsolicited broker must do with the suitability information it obtains, since there is absolutely no logical reason for an unsolicited broker to possess it. 3
2. The Updating Requirement
In the context of the full service broker, the requirement that the broker-dealer deliver to each customer a copy of the new account record is not unreasonable. Each customer should know the facts upon which their broker’s recommendations are based. Simple analysis concludes that the burden created by mailing or otherwise delivering this information to the customer upon opening an account is justified by the overall benefit to the customer. That the ability to obtain a concise overview of the essential facts upon which a recommendation is based would also greatly assist state securities examiners in their periodic inspections of full service brokers only bolsters the conclusion.
However, this analysis does not apply to unsolicited brokers. In the unsolicited broker context, the only information required by proposed rule 17a-3(a)(6) which would appear on the account record is the customer name and address. As stated, no suitability information should be required. Therefore, the proposed requirement to actively request updates of the information as it applies to unsolicited brokers is inapposite. The value of regularly requesting updates from customers as to whether their name and address changed by mailing the a copy of an account record to their current addresses is zero. Compared to the expense, which even the Commission calculates as astronomical, the proposal is simply unreasonable.
The Firms currently maintain over 9,692,701 customer accounts. We estimate that we represent well over seven percent of the average daily volume on each of the NYSE and NASDAQ each day. Using these calculations to assume that the entire securities industry maintains over sixty million customer accounts, and pays the same average 24.4 cents per piece for its bulk mail as the Firms do, the postage alone would cost the industry $1,464,000,000.00 every three years just to mail the updated forms to customers. 4 This does not take into consideration the manpower and/or systems programming required to generate the account record and prepare the mailing as well as the cost of processing changes received in response to the mailing.
That having been said, this proposal begs a reasonable alternative. Since even the proposed process depends on customer cooperation, more effective alternatives are available at a small fraction of the cost. One alternative is that the account record sent to each customer at the inception of their account be required to contain a notice that informs customers of the need to update their account information as often as necessary. 5 A prominent notice on a document that the customer will keep and periodically review could produce a far greater response rate than another piece of mail.
Another alternative is to require that the broker-dealer include on (or with) one customer statement every three years a similar statement requesting that the customers contact the broker-dealer to provide current information concerning their address, etc. 6 The chance that a customer will read this notice (and therefore the response rate) is exponentially increased, as it appears on a document that we must presume is carefully reviewed. In addition, by sending it to customers who receive a quarterly statement, we will capture only customers with positions or balances in their account, thus eliminating the many customers with zero cash balances and without securities positions. 7 Responses requiring changes will likely result in the creation of a new account record to be signed by the customer.
For these reasons, we ask that the Commission eliminate the updating requirement of the account record rule – at least as to unsolicited brokers. In the alternative, we urge the Commission to consider adopting one of the stated alternatives. They will produce an even more effective result at a fraction of the cost to the industry and, therefore to customers.
3. Changes in Customer Name or Address
Another portion of the rule would require the creation and retention of documents which are most likely already created and retained today. That is the requirement that changes of name or address be verified by resending the account record. This requirement is duplicative of an existing process and its relative value does not justify tampering with a process that already works.
Currently, upon a change in account name or address, most firms mail a notice of the change to the past address of the customers, some firms mail the notice to the new address, and all of the Firms have some address verification procedure in place. This system works and records of the follow up mailing are retained on a separate document retained in the ordinary course. To require that, in addition to the notice, the entire account record be resent to the customer will result in unnecessary expense and customer confusion. While the records of address change verification are retained separate from new account forms, they are readily available to the state regulators today. The benefit to them is minimal considering the similarities between the current process and the proposed process.
For these reasons, we ask that the Commission eliminate the requirement that broker-dealers resend the entire account record upon notice of a name or address change. In the alternative, we ask that the rule include a requirement that notice of a name or address change be given at the old address and that evidence of that notice be retained, but that the evidence need not be in the form of an amendment to the account record.
Other Items
1. Reports Concerning Potential Sales Practice Violations
For the (stated) reasons that unsolicited broker-dealers should not be required to obtain, retain and analyze customers’ investment objectives and risk tolerance, the rule should clarify that those same broker-dealers should not be required to create and store records which monitor unusual occurrences in customer accounts, such as frequent trading, unusually high commissions or trade corrections or cancellations.
Where Broker-dealers do not recommend orders they are not required to evaluate the suitability of any order or series or pattern of orders. To ask that they create and retain reports for the sole purpose of doing so would defy logic, waste valuable resources and put in the hands of unsolicited brokers information that, by their very nature, they do not use. 8 As stated earlier, if they are required to create and retain the information, and evaluate patterns of trading activity by customers, they must multiply their staff and change the nature of their business to such a great extent that they would effectively be legislated out of business. Therefore, we ask that the requirement that surveillance reports be created or retained contain an exemption for unsolicited brokers or that some clarifying language be included with the same effect.
2. Notice to Customers Regarding Complaints
Finally, we ask that the Commission clarify that the notice to customers required by Rule 17a-3(a)(17)(ii) in which customers are provided the address and telephone number to which they should direct complaints may take the form of a notice on customer statements. We believe that this is the process used by most firms today, and its inclusion in the rule would provide needed guidance.
We again thank you for your time and consideration of our comments. If you have any questions, please do not hesitate to contact the undersigned, as we would be glad to discuss our comments generally or specifically.
Sincerely,
Ameritrade (Inc.) Charles Schwab & Co., Inc.
Michael J. Anderson Brian D. Bellardo
President, Ameritrade (Inc.) Vice President
Associate General Counsel
Discover Brokerage Direct, Inc. DLJdirect Inc.
Mary Curran Denise Benou Stires
General Counsel Senior Vice President
Vice President Vice President, Compliance
Chief Compliance Officer
Waterhouse Securities, Inc.
Richard H. Neiman
Executive Vice President
General Counsel