December 8, 1998
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 6-9
SEC Release No. 34-40518
File No. S7-26-98
Please accept this letter on behalf of the Arkansas Securities Department (the "Department") in support of Release No. 34-40518, Books and Records Requirements for Brokers and Dealers Under the Securities Exchange Act of 1934 (the "Proposed Rule"). We are pleased to have the opportunity to comment on this important area of regulation, and we applaud the efforts made by the Commission in striking a balance regarding the interests of investors, brokerage firms, and regulators. We have also taken this as an opportunity to offer specific comments which we feel would enhance the efficiency of regulation under the Proposed Rule, while avoiding the imposition of unnecessary costs to those firms to which it applies.
We strongly support the Proposed Rule’s requirement that certain "core" records be maintained at the "local office", identified in the Proposed Rule as any location from which two or more associated persons regularly conduct securities business. In fact, we urge the Commission to consider requiring such records to be maintained in every office, including those in which only one associated person conducts business. Small offices, by their nature, pose an increased opportunity for unscrupulous agents to avoid detection when improper activity is taking place. In such circumstances, the broker who is committing a misdeed may be the same individual charged with supervision of the office. Often, due to the relatively small amount of business done in small offices, the firm is reluctant to dedicate the resources necessary to maintain an extensive oversight program, including regular on-site inspections. If such inspections are conducted at all, they typically occur only once per year, and then only on an announced basis.
Arkansas is primarily a rural state with few population centers. As a result, small offices, most often composed of only one or two registered individuals represent the vast majority of brokerage firms that maintain offices in our state. A survey of six national brokerage firms maintaining locations in Arkansas 1 reveals that out of a total of 162 locations, only 35% are locations in which more than two associated persons regularly conduct securities business. Perhaps even more than those states in which a much greater number of agents are registered, we see the particular abuses which can be wrought by unscrupulous agents in small offices when they are not monitored closely by their firm. It is our belief that the requirement that core records be maintained at such locations would enhance the ability of regulators to more readily identify potential trading abuses that can occur in such relatively unsupervised locations. Such abuses may include the sale of products not approved by the firm (often referred to as "selling away"), the recommendation of unsuitable investments based upon inadequate or incorrect customer information, and the presence of unapproved and inadequate sales literature or "scripts" of which the firm is unaware, to name only a few. Without a requirement that records be maintained at the local level, regulators are often met with the response that requested records are either nonexistent, or that they are located in the firm’s home office, which is invariably located hundreds, perhaps thousands, of miles away. The resulting delay in obtaining and reviewing whatever records are then furnished by the home office can result in the additional loss of customers’ funds and the destruction or secretion of documents or other evidence, as well as a general discontinuity in the examination process. Where it might be entirely feasible to conduct a spot examination of selected and targeted records, including customer complaints, in a single day were the records available on premises, the examination may drag into days or even weeks when the regulator is forced to resort to some distant office for the records. At the very least, such a delay detracts from a regulator’s ability to "put all the apples in one basket" at the site. As a result, there may well be instances when sophisticated misconduct may go unrecognized as a result of the break in the examination procedure. Additionally, when such a delay takes place, firms have the opportunity to review the records prior to review by the regulator. Although this does not necessarily result in a "cleansing" or "purification" of the records, it does often afford the firm the opportunity to talk to the individuals involved in the activity in question, which may well affect such individuals’ responses when later questioned by the regulator.
It is our belief that, contrary to representations which have been voiced by some members of industry, to require the records identified in the Proposed Rule to be kept in the local offices will not impose much, if any, additional burden or expense to firms, and what little burden that may result is certainly outweighed by the efficiency in the examination and regulatory process that will result. Our belief is based, in part, upon the following facts:
• The records required to be maintained under the Proposed Rule are "core" records that are necessary to keep in order not only to supervise the agents and local office properly, but also to effectively manage costs. In fact, it is our observation that many of the records that are required are already being maintained in the offices, thus negating any additional cost factors to the firms.
• Many broker-dealers, particularly the larger firms, maintain a number of the required records electronically, affording immediate access via a computer terminal without requiring on-site, hard copy paper storage.
• The records required under the Proposed Rule are records that each agent in the office should be able to interpret and explain, such as new account records, blotters, order tickets, correspondence, and customer complaint records. Such records are of such an elemental nature that an agent must necessarily be able to interpret them in order to transact business. Conversely, they are not of such a complicated or esoteric nature that a highly trained compliance or legal expert must be on hand to explain or interpret such records.
Should the Commission determine that the need for regulators to be able to obtain records onsite even in locations in which only one associated person conducts business is outweighed by the burden or expense imposed upon industry by such a requirement, we strongly support the requirement that the records required under the Proposed Rule be maintained in a central location within the state in which such one person locations are situated. Although neither as efficient nor effective as requiring onsite records, the centralized location within the state’s boundaries and court jurisdiction is a tremendous improvement over the present post-NSMIA situation in which records, if they exist at all, are invariably maintained in New York or some other distant location.
The Department supports the Commission’s position as set forth in the Proposed Rule regarding the particular "core" records required to be maintained. It is our belief that many of the particular records identified, particularly trade blotters, order tickets, confirmations, new account records, commission runs, and customer correspondence and complaints, are already maintained by firms, not necessarily because they are required to be maintained, but because they are necessary to effectively and profitably run a brokerage house. The Proposed Rule adds very little in the way of requiring additional records, but much in the way of clarifying the form and content of these records and the state regulators’ ability to access them. Such clarification should, in fact, reduce the expenses to firms in maintaining records since, under the Proposed Rule, all record keeping requirements will be uniform, and firms will be allowed to maintain such records in electronic format, provided timely access is available upon request. Our comments as to the particular records required are as follows:
The Department supports the Commission’s position regarding order tickets, with the exception of the failure to require a notation on the order ticket as to whether the order was solicited by the firm or unsolicited. It has been our observation that most firms already note this fact because it may have a bearing on the duty of the firm regarding the suitability of its recommendations. To require such a notation would not unduly burden industry, and would, in some instances, give a clear indication of the type of customer involved and his level of sophistication.
The Department supports the requirement that firms be required to maintain and keep current information regarding each customer’s account, specifically the investment objectives, risk tolerance, income, assets, and other information upon which a reasonable determination of suitability can be based. In this regard, the Department suggests that each account record be required to also contain an indication of the customer’s past investment experience. Such an indication would provide additional guidance in determining the suitability of a particular investment for such customer.
Furthermore, the Department agrees that such information should be updated, at a minimum, every 36 months. However, such time frame should only be considered the minimum requirement with which a firm should comply, as opposed to a "safe haven". In addition, the Department agrees that such information should be furnished to the customer so that he has an opportunity to determine if it accurately reflects his understanding of his financial situation. Unfortunately, more than once have we observed situations in which an unscrupulous agent has completed a new information card based not on what the customer’s true financial situation was, but rather, based on the minimum levels of income or assets necessary to allow the agent to sell a particular investment to the customer. If the information on the account record is sent to the customer promptly after the opening of an account, this problem might be avoided.
The Department also supports the position that customer information should be maintained for each individual holding an interest in a joint account.
The Department takes the position that the requirement that customer complaints be maintained at the local office level should not be diluted by allowing a firm merely to maintain a log of complaints. Frequently, firms or brokers have quite a different perspective concerning customer complaints than the customer making the complaint. It is important that a regulator examining an office for possible trade practice violations be able to make an accurate assessment of the complaints received by the office. Allowing this information to be "edited", often by the very broker about whom the complaint has been written, serves no justifiable purpose. Certainly, this is not a situation where industry can reasonably claim that the additional storage space required to house such records is too expensive. If there are so many complaints on an office that it becomes too expensive to store them, the office is probably exactly the sort which needs to be examined. Clearly, the need to ascertain the true nature of a complaint far outweighs the burden and expense of requiring a copy of the actual complaint to be maintained in each office.
The Department also is of the position that the customer complaints should be maintained in a file separate and apart from correspondence files. Although it may be very appropriate to include a copy of the complaint in a customer’s correspondence file, there should exist an entirely separate file that can be easily accessed to determine all of the complaints that have been received by the office.
Further, the Department suggests that not only should written complaints be required to be maintained at the local office level, but also a record of verbal customer complaints should be required to be maintained. Although less reliable than the actual writing scribed by the customer, such a record may also serve to alert examiners of the need for further investigation.
Commission and compensation records and reports are universally kept not only by brokerage firms, but also usually by the agents employed by the firms, albeit often in a less formal fashion. The requirement that these records be either maintained or capable of being created upon request is neither unreasonable nor burdensome. Such records are frequently instructive in investigating possible sales practice abuses or developing cases involving unsuitable recommendations. Such record should contain, at a minimum, each transaction for which the agent was compensated, the customer account in which the transaction occurred, the date of the transaction, and the amount of the compensation. The Department strongly supports the requirement that these records be maintained.
The Department, strongly supports the Proposed Rule in its present form except for those matters set forth above, and encourages the Commission to take measures to promptly put it into force. In the present post-NSMIA era of regulation, the ability of state regulators to conduct meaningful, efficient examinations of trade practices in brokerage firms has been diminished by the lack of enforceable rules requiring the maintenance of core records. The Proposed Rule promises to correct this situation by giving state regulators much needed tools, while balancing the industry’s concerns for cost efficient, reasonable regulation.
Sincerely,
Mac Dodson
Commissioner
-[1]- A. G. Edwards & Sons, Inc., American Express Financial Advisers, Inc., Dean Witter Reynolds, Inc., Edward D. Jones & Co., L.P., Merrill Lynch, Pierce, Fenner & Smith, Inc., and Salomon Smith Barney, Inc.