Jonathan G. Katz, Esq.
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
PaineWebber Incorporated ("PaineWebber") submits this letter in response to the request by the Securities and Exchange Commission (the "Commission"), set forth in Securities Exchange Act Release No. 34-37850 (the "Release"), for comments regarding proposed amendments to the broker-dealer books and records provisions. 1 The proposed amendments, among other things, would require broker-dealers to maintain additional records, to reflect certain information in multiple formats, to retain additional records and to store similar records at multiple locations.
The proposed amendments raise a number of concerns, many of which are discussed in letters submitted by the Securities Industry Association (the "SIA") and the Public Securities Association (the "PSA"). PaineWebber will not repeat the substance of those submissions here, but urges the Commission to consider carefully the comments of the SIA and the PSA. The comments concerning the proposed amendments to the books and records provisions set forth in this letter reflect the perspective of a retail broker-dealer with more than three hundred branch offices and six thousand registered representatives.
PaineWebber perceives two fundamental problems with the proposed amendments to the books and records provisions. First, in an apparent effort to address the states' perception of a lack of cooperation, the Commission is proposing to adopt rules that simply require the creation and maintenance of redundant records. In our experience cooperation is not the issue; if the problem were cooperation the states already possess the tools to deal with that issue. Second, a number of the proposed amendments, although framed as recordkeeping requirements, would impose substantive regulatory requirements.
Moreover, the Commission's Release fails to reflect a detailed analysis of the costs and burdens that would be imposed by the proposed amendments. Although the Commission has preliminarily concluded that ".burdens presented by the proposed amendments will not be substantial and that the proposed amendments will significantly increase levels of customer protection," 2 the Commission's Release fails to demonstrate the manner in which the proposed amendments would achieve the goal of increased investor protection. Further, it is unlikely that any increase in investor protection that will result from the adoption of the proposed books and records requirements will justify the substantial costs that will be imposed on broker-dealers in attempting to comply with the proposed amendments.
With respect to the effects on competition of the proposed amendments, the Release states that the Commission has considered the proposed amendments in light of the standards cited in Section 23(a)(2) of the Exchange Act and has preliminarily concluded that the proposed amendments ". .not likely impose any significant burden on competition not necessary or appropriate in furtherance of the Exchange Act, in that any burden would be less than that imposed by individual and possibly divergent state regulations." 3 The Release fails to note, however, that the states are precluded from adopting broker-dealer books and records provisions by the National Securities Market Improvement Act of 1996. 4 As a result, the Commission's analysis of the effects on competition of the proposed amendments appears to be illusory. The Release also fails to note that the legislation further provides that the Commission, in adopting rules and regulations, should consider whether the proposed rulemaking initiative "will promote efficiency, competition and capital formation" as well as protection of investors. 5 The proposed amendments to the books and records requirements will impose substantial burdens that ultimately will be borne by participants in the capital markets; accordingly, the proposed amendments will not promote efficiency, competition or capital formation.
In addition to the foregoing general observations regarding the proposed amendments to the books and records provisions, PaineWebber submits the following comments with respect to specific provisions that are particularly troublesome.
Client Profile Information Requirements
Proposed Rule 17a-3(a)(16), among other things, would require broker-dealers to maintain, for each customer, a record reflecting certain background information and a designation of the customer's investment objectives, including a specification of the percentage of investment capital that the customer would like to devote to speculative investments.
This provision is not designed to address the issue of access to records to be maintained by broker-dealers; rather, the apparent purpose of proposed rule 17a-3(a)(16) is to impose a substantive regulatory requirement on broker-dealers. The proposed rule would require broker-dealers to prepare and maintain a record that will likely be used to measure the suitability of recommendations by broker-dealers. Although this proposed amendment would appear to involve a significant rulemaking initiative, the Commission's Release does not identify a particular concern with respect to compliance by broker-dealers with their suitability obligations or the manner in which proposed Rule 17a-3(a)(16) would address a regulatory concern.
Moreover, the account form mandated by proposed Rule 17a-3(a)(16) will not facilitate determinations regarding the suitability of recommendations by broker-dealers. Recommendations that are fully consistent with investment objectives reflected on an account form, including the percentage of investment capital to be devoted to speculative securities, may appear questionable as a result of changes that occur over time. In the event that the value of non-speculative securities decreases over time while the value of speculative securities remains stable, a portfolio that was consistent with stated investment objectives may no longer appear to be so. A similar result may occur if securities that were not viewed as speculative when purchased decrease in value to the point that they may be deemed to be speculative investments.
In light of the foregoing, it is readily apparent that the adoption of proposed Rule 17a-3(a)(16), as drafted, will engender confusion, expose broker-dealers to unwarranted litigation risks and effectively impose a requirement that broker-dealers monitor customer portfolios daily for compliance with percentage limitations contained in the required account forms. Notwithstanding the Commission's statement that the proposed rule is not intended to impose on broker-dealers an obligation to monitor adherence to the designated percentage of investment capital to be devoted to speculative investments, a broker-dealer that fails to engage in such monitoring invariably will confront claims that transactions outside the parameters reflected on the account forms are unsuitable.
Compliance and Surveillance Requirements
Proposed Rule 17a-3(a)(19) would require broker-dealers to develop activity reports to "identify exceptional numerical occurrences, such as frequent trading in customer accounts, unusually high commissions, or an unusually high number of trade corrections or cancelled transactions, for management's attention and information."
Although framed as a books and records requirement, proposed Rule 17a-3(a)(19), in effect, mandates that broker-dealers adopt and implement certain procedures -- the preparation of reports for exceptional numerical occurrences -- as part of their supervisory policies and procedures. The Commission has consistently refrained from prescribing the adoption of particular supervisory policies and procedures, including reports designed to detect activity that exceeds certain parameters. Rather, the Commission has repeatedly emphasized that policies and procedures should be formulated in light of the nature and scope of the activities of the broker-dealer and the firm's personnel. 6 Proposed Rule 17a-3(a)(19), thus, marks a departure from the Commission's general policy regarding broker-dealer supervision.
The proposed rule also departs significantly from existing law with respect to a broker-dealer's exposure to sanctions for supervisory deficiencies. Under present law, a broker-dealer may be sanctioned if a person subject to its supervision violates certain designated provisions and the broker-dealer is unable to establish that it had adopted policies and procedures reasonably designed to prevent and detect violations of the federal securities laws and had a reasonable system for implementing such policies and procedures. Under the proposed rule, a broker-dealer arguably may be sanctioned merely for failing to have generated activity reports that identify exceptional numerical occurrences, irrespective of whether a violation of the securities laws has occurred. In that regard, the proposed rule is problematic because the term "exceptional numerical occurrences" is vague and susceptible to varying interpretations.
Audit or Examination Reports
Proposed Rule 17a-4(e)(5) would require a broker-dealer to preserve in an easily accessible place all audit or examination reports required by law or that are completed by a party other than the broker-dealer for a period of three years after the date of each such audit or examination report.
Although proposed rule 17a-4(e)(5) is designed to afford securities regulatory authorities greater access to reports prepared for broker-dealers, the proposed rule, if adopted, will likely have the opposite effect. A requirement that broker-dealers retain and make available audit and examination reports prepared by third parties will discourage brokerage firms from retaining professionals to examine and report on various aspects of the broker-dealer's business. In the event broker-dealers are dissuaded from promptly retaining professionals to conduct examinations and issue reports on various aspects of their business because of a requirement that such materials must be made available to regulatory authorities, even if protected by legally recognized privileges, the goals of enhancing investor protection will not be achieved.
Requirements Concerning Communications With Clients
Proposed Rule 17a-3(a)(17) would establish requirements regarding customer complaints. Among other things, broker-dealers would be required to note in a memorandum "any oral complaint from a customer received by an employee of a member, broker or dealer alleging facts that, if true, would constitute theft, conversion of funds, lack of suitability [or other prohibited activity] ." The memorandum must be prepared by a branch manager, principal or compliance department employee. Broker-dealers also would be required to provide routinely a prominent notice on its customer account statements that customers should put their complaints in writing. Further, broker-dealers would be required to maintain customer complaint files containing " all correspondence, memoranda, and other documents received or generated in connection with any complaint by or on behalf of a customer" including action taken by the broker-dealer in response to the complaint. (Emphasis added).
The proposed amendment that would require the preparation of memoranda reflecting certain oral complaints is problematic and would impose unwarranted burdens on broker-dealers and their personnel. As drafted, the rule would require the preparation of a memorandum if any employee of the broker-dealer received an oral complaint alleging specified conduct. Not every employee of a brokerage firm will possess the ability to assess whether a customer is complaining of conduct that constitutes one of the designated offenses. As a result, neither the firm nor the personnel designated by the rule as responsible for the preparation of memoranda concerning oral complaints may be able to comply with this requirement.
A requirement that broker-dealers routinely advise customers to set forth any complaints in writing is unnecessary; more importantly, such a requirement will not serve the goals of enhancing investor protection. PaineWebber attempts to address customer concerns, whether communicated orally or in writing, as expeditiously as possible. In that regard, PaineWebber has organized a unit that is dedicated exclusively to addressing sales practice complaints. The unit is directed by an attorney and is staffed by six additional attorneys and four support staff. The personnel in this unit attempt to elicit information from customers regarding their concerns in order facilitate a prompt and appropriate resolution of the matter. If the staff of this unit is required to advise customers that their concerns should be reduced to writing the flow of information will be impeded and the resolution of customer concerns will be delayed.
The proposed rule also would require broker-dealers to place all documents relating to a complaint by a customer, including documents protected by the attorney-client privilege and the work product doctrine in a customer complaint file. This requirement may increase unjustifiably the possibility that protected documents are disclosed to third parties and, accordingly, raise the possibility of a waiver of the attorney-client privilege or the work product doctrine. This could inhibit rather than encourage firms to evaluate legal exposure and respond deal promptly to customer complaints.
Duplicative and Burdensome Recordkeeping Requirements
Record Form and Access
The proposed amendments to Rule 17a-4(j)(1) add several requirements. First, broker-dealers would be required to organize records "in a systematic and easily recognizable order, such as chronologically or alphabetically." Second, broker-dealers would be required to "make available to representatives of a securities regulatory authority an individual who is familiar with the records (or type of records) and qualified to explain them." Third, broker-dealers would be required to furnish "promptly" records requested by securities regulatory authorities. For purposes of this provision, the term "promptly" is defined to mean immediately if the records are located on the premises or within three days if the records are not located on the premises.
The protection of investors will not be measurably increased through the adoption by the federal government of a provision that mandates the manner in which a broker-dealer maintains its files. Broker-dealers organize their records according to their business needs and those needs include the ability to retrieve information. Thus, the proposed amendments are not likely to significantly enhance access to information by regulatory authorities. Rather, the proposed amendment will likely impose unnecessary and unwarranted costs as broker-dealers would likely be required to maintain multiple records in order to conduct their business and comply with this recordkeeping requirement.
Furthermore, the period of time within which broker-dealers would be required to produce requested records to securities regulatory authorities pursuant to proposed Rule 17a-4(j) is also problematic. While securities regulatory authorities may desire an objective standard against which to measure a broker-dealer's obligation to produce requested records, the time frames set forth in Rule 17a-4(j)(2) do not afford broker-dealers the opportunity to either gather the requested records or to review the records prior to production in order to, among other things, ensure that privileged documents are not unintentionally provided to regulatory authorities.
The proposed amendments to Rule 17a-4(b)(4) would require broker-dealers to create and maintain a record that all outgoing communications have been approved by a principal of the member. The proposed amendments also provide that all communications sent to or received regarding a certain account must be maintained in a file with all other communications pertaining to that account.
Although framed as a recordkeeping provision, a rule that would require the approval by a principal of all outgoing communications would require broker-dealers to adopt a specific supervisory procedure. As noted above, the Commission and the securities self-regulatory organizations historically have refrained from mandating the adoption of specific supervisory procedures. In that regard, the proposed amendment is at odds with a New York Stock Exchange rule proposal, presently before the Commission, that would permit broker-dealers to formulate their own procedures regarding the review of registered representatives' communications with the public. 7
Proposed Rule 17a-3(a)(18) would require the creation of records showing all commissions, overrides and other compensation (including any bonus) by transaction, the person(s) receiving the compensation, the customer account number, the date of the transaction and the name of the security involved. The broker-dealer must also be able to demonstrate and document the method by which compensation based on factors other than remuneration per trade is earned.
Proposed Rule 17a-3(a)(18) would impose costly and unnecessary burdens on broker-dealers. PaineWebber, like many brokerage firms, does not presently prepare a report which sets forth compensation received on a per transaction basis, the investment executive receiving the compensation, customer account number, the date of the transaction and the name of the security. Based upon PaineWebber's experience, regulatory authorities rarely request information in the form prescribed by proposed rule 17a-3(a)(18). To the extent that a representative of a securities regulatory authority requests such information, it may be obtained reasonably promptly. Accordingly, there does not appear to be a basis for requiring broker-dealers to incur the significant costs of preparing such reports.
Headquarter and Local Office Requirements
Proposed Rule 17a-4(l)(1) would require broker-dealers to maintain all records at its headquarters office and to maintain certain specified records at local offices.
A requirement that broker-dealers maintain certain designated records at local offices does not appear to be warranted in light of the fact that generally broker-dealers can provide promptly records maintained at their headquarters to regulatory authorities conducting an examination of a branch office. The only rationale that has been proffered for the requirement to maintain records at local offices is the convenience of state securities authorities. The Release does not set forth an adequate justification for the considerable costs that broker-dealers would incur in attempting to comply with this proposed requirement.
Designation of Principals
Proposed Rule 17a-4(k) would require broker-dealers to designate a principal to ensure compliance with the requirements of the books and records provisions.
Under existing law, a failure to comply with the books and records provisions could result in an enforcement action alleging a violation of the applicable provision by the broker-dealer or aiding and abetting a violation of the recordkeeping requirements by an associated person. Additionally, both the firm and supervisory personnel, under certain circumstances, could be exposed to failure to supervise charges. In light of the existing regulatory structure there does not appear to be a need for a provision that would mandate that a firm designate a principal to ensure compliance with the books and records requirements. The Commission should continue to afford broker-dealers the latitude to develop policies and procedures and allocate responsibilities in a manner that is tailored to the firm's activities and personnel.
PaineWebber appreciates the opportunity to comment on the proposed amendments to the broker-dealer books and records provisions. As noted above, if PaineWebber's examination experience is at all illustrative, the proposal seeks to address a problem that does not exist. It is unlikely that the proposed amendments will enhance significantly investor protection as many of the provisions merely require the same information to be maintained in multiple formats and at multiple locations. Any increase in investor protection that would result from the adoption of the proposed amendments is outweighed by the costs and burdens that would be imposed upon broker-dealers. As noted above, securities regulatory authorities presently have the means and ability to act in the public interest. Accordingly, PaineWebber urges the Commission not to adopt the proposed amendments to the books and records provisions.
Herbert F. Janick, III
Proposed Rule 17a-4(e)(6) would require broker-dealers to maintain compliance, supervisory and procedures manuals for a period of three years after termination of the use of such materials. The proposed rule would further require the retention of manuals that pertain to the operation of a local office at such office for a period of three years after termination of the use of such manual.
Although a requirement to maintain compliance, supervision and procedures manuals for a period of three years after termination of use of each such manual would be unobjectionable, the requirement to maintain copies of manuals that pertain to the particular offices in such offices imposes burdensome and unnecessary costs on brokerage firms, in light of the fact that brokerage firms continually modify such manuals.
Preservation of Records
The proposed amendments to rule 17a-4(a) would require that designated records be maintained in an easily accessible place for six years. The proposed amendments to Rule 17a-4(b) would require specified records to be maintained in an easily accessible place for three years.
The present record retention provisions require broker-dealers to retain specified records in an easily accessible place for two years and permit broker-dealers to store such records at other locations for the remainder of the retention periods. As revised, Rules 17a-4(a) and 17a-4(b) would require broker-dealers to maintain designated records in an easily accessible place for the entire record retention period. Other proposed amendments to the books and records provisions would require broker-dealers to make and keep additional records and to store certain records at both headquarters and local offices. The cumulative effect of the proposed record retention provisions will be significant. Brokerage firms will be required to alter their record storage arrangements and the cost will likely be substantial. Also, broker-dealers will likely incur considerable personnel costs in order to maintain the required records at headquarters and local offices.
The Commission's apparent assumption that technological developments will facilitate the storage and retrieval of data and that, therefore, the proposed revisions will not impose substantial burdens is misguided. Many of the records required by the proposed amendments (e.g., customer complaint files, records relating to associated persons, and various communications) will be maintained in hard copy. Accordingly, broker-dealers will incur considerable increases in costs attributable to record storage and retrieval. The costs that broker-dealers will incur in complying with the proposed amendments would appear to outweigh the need for immediate access to records that relate to events occurring more than two years prior to a request by a state securities authority.
Records Concerning Associated Persons
Proposed Rule 17a-3(20) would require broker-dealers to maintain additional records concerning associated persons, including all registration application forms, termination forms and amendments; all licenses and other state registration documents; all contracts; a summary of each associated person's compensation agreement with the broker-dealer; copies of all written inquiries and customer complaints concerning each associated person; records showing that upon every change in licensing affecting an associated person, such associated person has been notified of such changes, including any restrictions or other provisions affecting the associated person's license; a client trading record listing all trades in chronological order for all customers of each associated person and including the total dollar amount of remuneration per trade.
Proposed Rule 17a-3(a)(20) would require broker-dealers to generate and/or store considerable information concerning each associated person of the broker-dealer and many of the requirements of this proposed rule are unnecessary and costly.
The requirement imposed by proposed Rule 17a-3(a)(20)(iii) that the broker-dealer make and keep records "pertaining to the relationship between each associated person and the member, broker or dealer" is vague and brokerage firms will be unable to comply with this proposed requirement. The requirement imposed by proposed Rule 17a-3(a)(20)(iv) that a broker-dealer maintain "a summary of each person's compensation agreement" is burdensome in light of the fact that such arrangements are modified frequently and the fact that information concerning the compensation agreement for particular associated persons may be provided promptly to representatives of securities regulatory authorities in the event that such information is requested during the course of an examination.
The requirement imposed by proposed Rule 17a-3(a)(17)(vi) that broker-dealers maintain records "showing that upon every change in licensing affecting an associated person, such associated person has been notified of such changes, including any restrictions or other provisions affecting the associated person's license" appears to involve another attempt to require broker-dealers to adopt and implement specific supervisory procedures.
The requirement imposed by proposed Rule 17a-3(a)(20)(vii) that a broker-dealer make and keep records reflecting all trades in chronological order for all customers of each associated person would impose a substantial burden and would appear to be unnecessary in light of the fact that such information generally would be retrievable in a reasonable period
Advertising and Marketing Materials
Proposed Rule 17a-4(b)(10) would require broker-dealers to maintain records of all advertising or marketing materials, including audio and video tapes, used by the broker-dealer or any associated person to offer or sell any security. This provision also would require the retention of "all documents and other records that are intended exclusively for internal use." The proposal would require the approval by a principal of all documents or other records used to offer or sell any security and would also require the creation and retention of a record of such approval.
By promulgating a rule requiring a principal to approve all documents used to sell any security, the Commission would be prescribing the adoption of supervisory procedures by broker-dealers and again departing from its general policy of permitting broker-dealers to develop policies and procedures that are tailored to each firm's business and personnel.
Moreover, the proposed rule is exceedingly broad, requiring the retention and approval of any record that relates to efforts to offer or sell any security. As with many of the proposed amendments to the existing books and records provisions, proposed Rule 17a-4(b)(10) will impose costs on brokerage firms that are not justified.
Information Relating to Recommended Securities
Proposed Rule 17a-4(b)(11) would require the retention of "any information relating to the basis for any recommendation of a security by the member, broker or dealer with respect to each security underwritten by the member, broker or dealer and each security that the member, broker or dealer trades as principal and recommends to its customers."
A requirement that broker-dealers retain " any information" in its possession relating to the basis for a recommendation is overly broad and would, like other proposed amendments to the books and records provisions, impose unnecessary burdens and costs on broker-dealers.
|1||Rules 17a-3 and 17a-4, 17 C.F.R. 240.17a-3 and 240.17a-4.|
|2||61 F. R. at 55597|
|3||61 F. R. at 55597|
|4||National Securities Markets Improvement Act of 1996, sec. 102(b) (amending 15 U.S.C. § 78o).|
|5||National Securities Markets Improvement Act of 1996, sec. 106(b) (amending 15 U.S.C. § 78c).|
|6||See, e.g., Section 15(f) of the Exchange Act, 15 U.S.C. 78o(f). Section 15(f) authorizes the Commission to prescribe rules requiring broker-dealers to adopt policies and procedures designed to prevent and detect insider trading. However, the Commission, in accordance with its general policy regarding supervisory procedures, has refrained from adopting rules which specify the policies and procedures that broker-dealers must adopt.|
|7||Securities Exchange Act Release No. 37941.|