WILLKIE FARR & GALLAGHER
787 Seventh Avenue
New York, NY 10019-6099
Roger D. Blanc
December 9, 1998
Securities and Exchange Commission
Mail Stop 6-9
450 Fifth Street, N.W.
Washington, DC 20549
Attention: Mr. Jonathan G. Katz, Secretary
Re: Commission File No. S7-26-98
Ladies and Gentlemen:
We are submitting this letter on behalf of Credit Suisse First Boston Corporation; Deutsche Bank Securities Inc.; Goldman, Sachs & Co.; Lehman Brothers Inc.; PaineWebber Incorporated; Prudential Securities Incorporated; SG Cowen Securities Corporation; and Warburg Dillon Read LLC (collectively, the "Firms"), in response to the Commission's request for comment in Securities Exchange Act Release No. 40518 (October 2, 1998) (the "Proposing Release"), in which the Commission proposed for comment revised amendments (the "Proposed Amendments") to the broker-dealer books and records rules, Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 (the "Exchange Act"). We appreciate the opportunity to comment on the Proposed Amendments and we hope that our comments will be useful to the Commission and the staff.
We wish to begin by commending the Commission for its response in the Proposing Release to several of the comments received on the earlier rule proposal set forth in Securities Exchange Act Release No. 37850 (October 22, 1996) (the "Proposing Release"), in which the Commission proposed for comment an initial set of amendments to Rules 17a-3 and 17a-4. We point out, however, that the Commission's existing recordkeeping rules adequately
facilitate regulation and surveillance of broker-dealers. To promote efficiency and reduce duplicative and unnecessary regulation, the Congress in 1996 took away from the states the power to impose their own independent recordkeeping requirements for broker-dealers. 1 The Commission should not diminish the impact of that deregulatory legislation by adopting new regulations at the behest of the state regulators in the absence of a strong demonstration of need, which probably would have to be confirmed through further congressional legislation. 2
The existing system of recordkeeping requirements, administered by the Commission and by the self-regulatory organizations, has been carefully thought through and has worked well. The existing rules require broker-dealers to keep adequate books and records in a readily accessible place and that they produce them promptly to assist the Commission and the self-regulatory organizations in conducting surveillance and examinations. Particularly in view of the Congress's very recent legislation in this area, the Commission should not adopt the instant proposals without a strong, factually based, point-by-point demonstration of need for each of the new requirements.
Our comments on specific aspects of the proposals follow.
1. Time of execution
The Commission notes in the Release that paragraphs (a)(6) and (a)(7) of Rule 17a-3 currently require that brokerage order memoranda and dealer purchase and sale memoranda include information concerning the terms and conditions of an order, including "to the extent feasible" the time of execution or cancellation of the order. 3 The Commission further comments that the phrase "to the extent feasible" means that if the precise time of execution is not available, the broker-dealer must note the approximate time of execution. 4 If the Commission determines, notwithstanding our general comment above on the absence of demonstrated need for these rules, to adopt this particular provision, it would be helpful if the Commission would add a further clarification to the effect that a firm that gives up an order to another firm for execution need record only the time when it received a report of execution from the executing firm. In cases where a firm has given an order to another broker-dealer for execution, as frequently happens when the order is in a security in which the firm does not make a market, it typically would capture the time when it received a report of execution. Often, that would be very soon after the order was executed, but only the executing broker would have generated a record showing the exact time of execution. In the course of an inquiry by a regulator into the execution of particular orders, it would be reasonable to expect the regulator to make inquiry of the executing broker if the regulator needed to know the precise time of execution. There certainly is no business reason why, on every trade given out to another broker for execution, the broker that gave up the order for execution would need to know, let alone record in its records, the precise time of execution. Requiring that it make that inquiry and capture the information in its records on every trade would impose inappropriate burdens and costs without any sufficient regulatory justification.
2. Identity of order handlers
The proposed requirement that an order ticket note the identity of any person other than the registered representative who entered or accepted the order on behalf of a customer is unnecessarily burdensome. The expressed rationale, to "allow securities examiners to determine whether particular persons, including unregistered persons, are engaged in sales practice violations," 5 misses a basic point. The Firms, and in all likelihood virtually all other firms in the securities industry, have established policies and procedures prohibiting unregistered persons from accepting or handling orders. Unauthorized deviations from such policies and procedures would be unlikely to result in entries into a broker-dealer's written records since persons who are deliberately or even inadvertently skirting a brokerage firm's internal policies are unlikely to note their non-compliance on order tickets.
What the requirement instead might do would be to set broker-dealers up for a per se books-and-records violation in any such case, even if they did not have any reasonable reason to suspect, or opportunity to discover, the instances of non-compliance with the registration requirements and the broker-dealers' own policies. If, on the other hand, a brokerage firm did in fact have notice of instances of non-compliance with the existing registration requirements and nevertheless failed to take action to cure that problem, it would expose itself to possible prosecution under an existing rule of the National Association of Securities Dealers, Inc. (the "NASD"). 6 There is no reason to add another possible ground for prosecution, particularly in guise of a recordkeeping rule. In a case where there are sales practice violations unrelated to registration of the personnel, the identity of all persons involved in a given instance can be ascertained upon regulatory inquiry without the firm's having to adopt for all its order flow the elaborate, burdensome and unnecessary recordkeeping procedure proposed.
3. Natural person joint accounts
The Commission sought comment on whether firms should keep records as to all natural person members of a joint account or, alternatively, only for those individuals authorized to effect transactions for the joint account. 7 We suggest that the current requirement, that firms keep records as to the persons authorized to effect transactions for the account, is sufficient. Firms today collect information by questionnaire as to whether the owners that are not identified by name are affiliated with other firms in the securities industry. 8 The existing rule requires broker-dealers to record the beneficial owner of an account but, in the case of a joint account or an account of a corporation, need only record the identities of the person or persons authorized to transact business for the account. 9 The Commission has not suggested any new reasons why that provision, which has stood for many years, should be altered and the Firms are not aware of any need for an alteration.
4. Time of order entry
The proposed requirement that broker-dealers record the time of order entry duplicates, to the extent it relates to Nasdaq securities, the Order Audit Trail System requirements 10 that currently are being phased in by the NASD. To the extent the proposal relates to orders on the floor of the New York Stock Exchange (the "NYSE"), it would duplicate NYSE Rule 123. Since the proposed requirement would necessitate recordation of both the time the order was received from the customer and, to the extent feasible, the time of execution, also requiring capture in a brokerage firm's records of the time when the order was entered into the firm's trading queue by a sales trader or other employee who received the customer order in a security not covered by the NASD or NYSE rule, such as certain fixed-income securities and foreign securities traded over the counter, would not contribute meaningfully to regulatory inspection or examination. In many cases, the time of order entry would quickly follow the time the orders were received, but that would not be the case where the sales trader was given discretion as to the time and manner of order entry, as would be the case with not-held orders.
The Commission's proposed requirement would require another layer of complex and expensive order-capturing capacity. Particularly given the current demands on broker-dealers' systems capacity occasioned by Y2K compliance, conversion to the Euro and other pressing needs, this additional level of recordkeeping is oppressive and not justified by any significant regulatory need or likely yield.
5. Local offices
The definition in proposed paragraph (g)(1) of Rule 17a-3 of the term "local office", which is used to determine the places at which certain records have to be kept locally, has been modified from a one-person minimum size to a two-person minimum. This still seems unduly burdensome. A firm that maintains several such "offices" within a given state, for example, should be able to designate a single office (of whatever size) to be the record repository. In fact, this alternative is proposed to be used for one-person offices 11 and should instead be applied more generally to the entire universe of local offices. In addition, some firms maintain satellite offices that are used on only a part-time basis; it would not be sensible to require firms to keep personnel and records at those satellite offices for regulatory purposes at times when no business was being conducted there. If the purpose of the requirement would be to facilitate state inspections, having a single record repository within a given state, such as an office of supervisory jurisdiction, would seem to make state inspections more efficient. It also would be far less burdensome on the industry than the current proposal. 12
6. Local vs. centralized records
If the Commission decides, notwithstanding our general comment above on the absence of demonstrated need for these rules, to require the placement and/or retention of records in local offices, it should make several distinctions. First, the requirement that order information reside in local offices as well as in the firm's central or headquarters office should not apply to institutional orders that are handled by a firm's trading desks. Today, in the Firms' experience, broker-dealers that do a retail business keep records of retail order flow in the office that generated the orders, but they do not do so for institutional business that the customer communicates directly to the firm's trading desk. There is not a compelling justification for making broker-dealers alter their current practices in this respect, particularly since the alteration would require costly and burdensome adjustments to a firm's record-generation and record-retention systems.
Another distinction the Commission should recognize, if it determines to go forward with a requirement for local record retention, is between order tickets and general human resources files such as personnel files and registration information. The latter are readily available to the state securities regulators over the CRD system and it would be duplicative and unnecessary for the broker-dealers also to maintain the registration records in their local offices.
Employee personnel files, however, are routinely maintained at a firm's headquarters or central filing facility. If only to preserve the confidentiality of what may be sensitive employment information, the Commission should not require that duplicate copies be stored in the branches. Such storage is not necessary as a matter of routine for regulatory purposes. If in a given instance a state examiner needs to review personnel files of an employee located within that state, the examiner should request the firm to produce the records.
Concerning customer complaints, there are some practical implications of the Commission's proposed action. Broker-dealers often refer customer complaints, in the first instance, to the branch to which they relate. It is quite reasonable to require the branches to retain copies of the complaints they have received. The Firms are concerned, however, that the proposed requirement that broker-dealers send to a local office any written complaint relating to an associated person in that office may compromise the integrity of internal investigations that the home office may be conducting. Particularly if the behavior of the branch manager is in question in such an investigation, firms should not be under any obligation to reveal that they have received one or more complaints or that they are undertaking an internal audit or investigation in response.
7. Same-day production of records
The Commission states in the Release that broker-dealers that elect not to retain records at a local office should have to produce the records on the same day as they are requested by a state examiner. 13 We suggest that this would impose unreasonable costs and other burdens on broker-dealers that do not store the records on CD-ROMS or optical disks. If the Commission concluded that it is necessary to adopt further regulation in this area, it could address the matter sufficiently to provide the state regulators with the records they need but without imposing an undue burden on the securities industry by instead requiring that the broker-dealers produce the records as soon as reasonably possible but in no event later than two business days after receiving a request by a state examiner.
8. Coordination of examinations
The Commission also asked whether there are more efficient means to promote federal-state regulatory cooperation than the current system of duplicative examinations. The Firms suggest, in that regard, that the SEC and the states pool their examination resources, or at least coordinate their deployment more effectively, so that they were not devoted to conducting largely duplicative examinations. Just as the Commission and the self-regulatory organizations rely on one another to perform examination and enforcement functions, and in that way achieve significant efficiencies, similar coordination and cooperation might be possible between the Commission, with its nationwide jurisdiction, and the state regulators, whose jurisdiction and resources are more limited.
In making that suggestion, we are of course assuming that the state regulators would not be subject to greater public disclosure requirements than currently apply the Commission under the Freedom of Information Act, which shield enforcement records from mandatory disclosure. If that is not the case, it may be that effective coordination would not be possible.
* * *
If we or any of the Firms may be of further service to the Commission or its staff in their evaluation of these matters, please let me know.
/s/ Roger D. Blanc
Roger D. Blanc
cc: The Hon. Arthur Levitt, Chairman
The Hon. Norman S. Johnson, Commissioner
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Paul R. Carey, Commissioner
The Hon. Laura S. Unger, Commissioner
Dr. Richard R. Lindsey, Director,
Division of Market Regulation
Robert L. D. Colby, Esq., Deputy Director,
Division of Market Regulation
Michael A. Macchiaroli, Esq., Associate Director,
Division of Market Regulation
Thomas K. McGowan, Esq., Assistant Director,
Division of Market Regulation
-- As the Commission is aware, Section 15(h) of the Exchange Act, added by the National Securities Markets Improvement Act of 1996, took away from the states the power to establish independent recordkeeping requirements for broker-dealers. While that provision required the Commission to "consult periodically" with the state securities commissions to determine the adequacy of the Commission's own recordkeeping regulations, it did not thereby authorize a substantial addition to the Commission's recordkeeping rules in the absence of demonstrated need, nor did it relieve the Commission of the need to justify its rulemaking under customary legal standards for agency rulemaking.
-- Section 3(f) of the Exchange Act requires that, in adopting rules under the Exchange Act, the Commission must consider, among other statutory purposes, whether the action "will promote efficiency, competition and capital formation." The instant proposals in no way serve those objectives and indeed, to the extent they impose unnecessary burdens and costs, would impede efficiency and competition.
-- Id. at Section III.A.
-- Id. at n.9.
-- Release in text following n.9.
-- See, e.g., NASD Interpretation IM-1000-3, under which an NASD member may be subject to disciplinary action by the NASD for failure to register an employee, who should be so registered, as a registered representative.
-- Id. at Section III.C.
-- This information is needed in view of, inter alia, the NASD's Free-Riding and Withholding Interpretation, NASD Interpretation IM-2110-1.
-- Rule 17a-3(a)(9), proviso. The Commission proposed over 20 years ago to revise that requirement to eliminate the proviso in view of concerns about abuse of foreign secrecy laws, but, after careful and extensive deliberation, did not adopt that proposal. See, e.g., Exchange Act Release Nos. 12055 (January 27, 1976), 13149 (January 10, 1977) and 13388 (March 18, 1977).
-- See NASD Rules 6950 through 6957.
-- Id. at Section III.G.
-- We note further that the Commission states in the Release that brokers would be required under proposed paragraph (f) of Rule 17a-3 to maintain "chronological" sales records. There is not, however, any current requirement under Rule 17a-3 that the records be chronological, nor do we see any reason why the Commission should propose any such requirement.
-- Id. at Section III.F.4.