|A.G. Edwards & Sons, Inc.|
One North Jefferson|
St. Louis, Missouri 63103
December 18, 2002
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File Nos. SR-NYSE-2002-34; SR-NYSE-2002-36; and SR-NASD-2002-162
Dear Mr. Katz:
A.G. Edwards & Sons, Inc. ("A.G.Edwards") appreciates the opportunity to comment on proposed rule changes submitted by the New York Stock Exchange, Inc. ("NYSE") and National Association of Securities Dealers, Inc. ("NASD") designed to enhance members' supervisory control procedures. A.G. Edwards is both a member organization of the NYSE and a member of the NASD, with a large nationwide retail branch network of over 700 "branch offices" as that term is proposed to be defined by the NYSE and the NASD. Because of differences between the proposals of the two regulatory entities, and related rules of the two entities, dual member firms such as A.G.Edwards would be required to meet the most stringent version of the proposed requirements to the extent they vary in the two proposals.
We appreciate the need for effective internal controls, and we are continually establishing and reassessing our policies and procedures to ensure appropriate supervision of firm activities. The proposals developed by the NYSE and NASD generally are consistent with good business practices for retail firms and, in many respects, mandate controls that firms already have in place. However, many firms with exemplary compliance records routinely meet their supervisory responsibilities without the stringent independent review requirements such as those proposed.
While many of the practices in the proposed rules certainly constitute "best practices," we believe the costs and the time involved in implementing certain provisions will be considerable, particularly for firms with large branch networks, and we question the need for these provisions in light of the many tools available to management and regulators to address supervisory issues. This is particularly troublesome in light of all the other regulatory initiatives recently adopted and currently pending
As discussed in more detail below, if strictly construed, the proposals would establish new requirements that could be extremely burdensome for firms to implement. A.G. Edwards, therefore, believes flexibility in certain areas is needed, particularly with respect to the requirements for independent reviews. A.G. Edwards also believes an exemption from certain provisions for institutional customer accounts would be appropriate. A.G. Edwards' specific comments follow.
Members are currently inundated with multiple requirements to meet new or proposed changes in laws and regulatory initiatives that have competing deadlines, make competing demands on scarce resources, particularly IT resources, and which demand large expenditures of capital.
Just to name a few such competing demands, there are ongoing, pending and proposed requirements relating to INSITE, best execution, trade reporting, straight thru processing (STP), Sections 17a-3 and 17a-4 (the "Books and Records rules", Anti-Money Laundering rules, research analyst issues, and the requirements of Sarbanes-Oxley.
There are many elements in the instant proposals which overlap with the requirements of those previously mentioned initiatives, and which make competing demands on the firm's time, resources and capital.
For example, proposed requirements regarding notations on order tickets are integrally related to new requirements under) the Books and Records rules, which are scheduled to become effective in May 2003. The clarification in the proposal relating to intra-day account designation changes, and the increased requirements for documentation and approval, require system enhancements to properly control this process that will affect many of the systems affected by STP.
Recognizing the extensive changes that would be required to firms' automated systems, the Commission authorized a phase-in period when adopting the Books and Records rules of 18 months. A.G. Edwards respectfully requests that the effective date of these new rules contain a similar period of time to meet the requirements.
Under SRO rules, firms must inspect their offices on a regular basis. Under NYSE rules, branch offices must be inspected at least annually. NASD rules require offices of supervisory jurisdiction be inspected annually and all others to be inspected according to a cycle, set out in the firm's written supervisory procedures, based on certain risk factors. Moreover, proposed amendments to the definition of branch office will increase substantially the number of offices that must be inspected. The result of the two NYSE proposed rule changes taken together would mean that NYSE member firms would have to inspect every office, including homes, vacation homes or convenience offices, meeting the definition of a "branch office", annually. NASD-only member firms still only have to inspect offices of supervisory jurisdiction annually with all others to be inspected according to a cycle, set out in the firm's written supervisory procedures, based on certain risk factors
The proposed rule changes present a huge burden for firms with far-reaching branch networks. There is no customer protection or regulatory interest served by requiring annual inspections of a location merely based on the number of days someone works from a location, if the location is not "held out" to the public, if no customer funds or securities are maintained at the location, and if the location is not used to conduct functions that occur in an office of supervisory jurisdiction.
In many firms, the individual responsible for the review of a producing branch manager will be a regional manager (or a person who reports to the regional manager). Even if a supervisor's compensation is based to some extent, either through bonus or override, on the production of individuals he or she supervises, the supervisor has the responsibility for ensuring compliance with all applicable laws and regulations. Indeed, some firms include bonuses for clean compliance records as a component of a supervisor's compensation.
A.G. Edwards urges the Commission to confirm that firm policies and procedures must meet certain basic principles, i.e., supervisors may not review their own activity, but that other scenarios that involve review by supervisory personnel in a hierarchical supervisory system will be sufficiently outside the chain of command to meet the independence requirements of the proposal. For example, if the producing manager's regional manager, or someone reporting to that regional manager conducts an inspection, this should be sufficiently independent to meet the requirements of the rule. A.G. Edwards believes such an interpretation is consistent with the intent of the proposed rules
Proposed NYSE Rule 342.23 requires "… establishment of procedures for independent verification and testing of … business activities separate and apart from the day-to-day supervision of such functions." This section should be clarified to allow member organizations to perform annual independent verifications and testing of controls on the areas of business that represent the highest risk to the member organization. The lower-risk business activities' controls should be tested and verified on a cycle basis, such as every three years. This approach is consistent with the risk-based audit process currently in place at most larger member organizations. Information relevant to this risk assessment process could be included in the annual report to the member organization's Chief Executive Officer.
The NYSE states in its proposal that it recognizes no single approach to internal controls can be appropriate for all business models given differences in organizational size, supervisory structure, scope of business activities, products offered, location of branch offices, etc. The controls established and implemented should reasonably conform to the nature of the business conducted. A.G. Edwards believes the proposals anticipate that this risk-based approach would be appropriate, but the proposals should be amended to explicitly so state.
It is unclear which individuals within the firm would be deemed sufficiently "independent" to perform the verification and testing. Firms have long been required to have a supervisory system in place and have had flexibility in developing these systems. The Commission should maintain flexibility in this area by confirming that the intent of the proposed rules is to set out general principles to which firms should conform their policies and procedures.
While a supervisor cannot supervise himself or herself, or verify and test policies that the supervisor is personally responsible for implementing, it should be permissible for verification and testing to be conducted by a more senior supervisor in a hierarchical supervisory structure.
The proposals should also make it clear that individuals within the firm would be able to participate in the risk assessment and review even if they had peripheral involvement in the activity being reviewed or some indirect benefit from the activity of the supervisor, such as a commission override. This should not compromise the independence of the verification and testing function.
Also, the fact a business unit conducting verification and testing might be involved in an aspect of the transaction should not taint the business unit's independence. For example, a branch manager may be the one who determines the essential facts and approves changes in the account name or designation of an order, while a person in the Home Office trade processing department may be charged with the independent verification and testing of that process even though the Trade Processing Department may have implemented the changes originally authorized by the Manager.
Both proposals provide that written documentation of the essential facts relied upon by a person approving a change in account name and designation of an order, must be "maintained in a central location". In many firms the person approving the change will be located in an Office of Supervisory Jurisdiction. The documentation should remain in the location where the determination and approval occurs, not in the Home Office. This is essential for audit and inspection purposes, and most certainly would be the desire of the various regulatory authorities that might be inspecting the location. The result of the current proposal would most likely require duplicate records.
The NYSE and NASD proposals contain virtually the same provision with respect to time and price discretion. Specifically, the proposed rule changes provide that the authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written, contrary indication signed and dated by the customer. In addition, both provisions require any exercise of time and price discretion to be reflected on the order ticket.
A.G. Edwards believes an institutional exemption from this provision would be appropriate. For the most part, institutions trade on a not-held basis and virtually all-institutional orders involve discretion on the part of the trader. Although most institutional orders will be day orders, it is not uncommon for a trader to be working a large order over the course of several days. Institutions are sophisticated investors who do not need the same level of protection as retail customers. Therefore, an institutional exemption from this provision would be appropriate.
A.G. Edwards supports the efforts of the NYSE and NASD to set out internal control requirements that would enhance firms' supervisory systems. Without more flexibility, however, the rules as proposed would require major changes in supervisory structures across the industry or costly alternatives that would be a burden on competition for firms with extensive branch networks. A.G. Edwards urges the Commission to consider the clarifications proposed above so that firms can meet their obligations with internal resources and minimal disruptions to existing supervisory structures. We further urge an extended time period to phase in the requirements of the proposed rules.
If you have any questions, or would like to discuss our comments further, please contact me at:
Brian C. Underwood
Senior Vice President - Director of Compliance
A.G. Edwards & Sons, Inc.
One North Jefferson
St. Louis, MO 631093
Phone: (314) 955-3711
Fax: (314) 955-4308
BRIAN C. UNDERWOOD
Senior Vice President - Director of Compliance