Federal Register / Vol. 62, No. 29 / Wednesday, February 12, 1997 / Rules and Regulations 6469

1See Securities Exchange Act Release Nos.

37619A (September 6, 1997) (‘‘Adopting Release’’),

37972 (November 22, 1996), 38110 (January 2,

1997), and 38139 (January 8, 1997). The

Commission notes that a broker-dealer’s duty of

best execution discussed in the Adopting Release

applies whether or not the security has been

phased-in under the Order Execution Rules.

2See letter from Bernard L. Madoff, Securities

Industry Association, to Richard R. Lindsey, dated

January 30, 1997, and letter from John N. Tognino,

Securities Traders Association, to Richard R.

Lindsey, dated January 31, 1997.

3The Commission also amended subsection

(a)(25)(ii) of the Quote Rule, thereby expanding the

coverage of the Quote Rule to all exchange-traded

securities. Thereafter, the Commission determined

that it was appropriate to make this aspect of the

amendments effective April 10, 1997. See Securities

Exchange Act Release No. 38110, supra note 1. The

present order does not change that date and,

therefore, the effective date of subsection (a)(25)(ii)

of the Quote Rule remains April 10, 1997.

4Currently, compliance with the Order Handling

Rules is required for 50 of the 1000 Nasdaq

securities with the highest average daily trading

volume. These 50 securities have been identified by

Nasdaq. Similarly, Nasdaq is to identify the next

two groups of 50 stocks to be phased-in under the

Order Handling Rules.

FOR FURTHER INFORMATION CONTACT:

Betsy Prout Lefler, Special Counsel, Gail

Marshall-Smith, Special Counsel, or

David Oestreicher, Special Counsel,

(202) 942–0158, Division of Market

Regulation, Securities and Exchange

Commission, 450 Fifth Street, NW., Mail

Stop 5–1, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

Background

On August 28, 1996, the Securities

and Exchange Commission

(‘‘Commission’’) adopted Rule 11Ac1–4,

the ‘‘Limit Order Display Rule,’’ and

amendments to Rule ‘‘Ac1–1, the ‘‘ECN

Amendment,’’ to require OTC market

makers and exchange specialists to

display certain customer limit orders,

and to publicly disseminate the best

prices that the OTC market maker or

exchange specialist has placed in

certain electronic communications

networks (‘‘ECNs’’), or to comply

indirectly with the ECN Amendment by

using an ECN that furnishes the best

market maker and specialist prices

therein to the public quotation system.

On January 20, 1997, the Order

Execution Rules became effective. As of

that date, compliance with the rules

became mandatory for all exchangetraded securities and 50 Nasdaq

securities. Compliance with the rules for

the remaining Nasdaq securities is to be

completed in accordance with a

schedule established by the

Commission.1 Under the previously

announced schedule, compliance with

the Order Handling Rules would have

been required with respect to another

100 Nasdaq securities on February 7,

1997, and another 850 Nasdaq securities

on February 28, 1997. In addition, on

March 28, 1997, compliance would have

been required with respect to all

remaining Nasdaq securities under the

ECN Rule, and with respect to another

1500 Nasdaq securities under the Limit

Order Display Rule. Thereafter,

compliance under the Limit Order

Display Rule was to be phased-in over

several months.

The Commission has been closely

monitoring the implementation of the

Order Execution Rules, and recently

received two letters from representatives

of numerous industry participants

(‘‘Industry Letters’’) requesting that the

Commission adopt a more conservative

schedule for implementing the Order

Execution Rules.2 Accordingly, the

Commission has determined that it is

appropriate to modify the schedule to

provide a more gradual phase-in to

allow market participants more time to

adapt to the Order Execution Rules.3

The new schedule is as follows: On

February 10, 1997, 50 Nasdaq securities,

and on February 24, 1997, an additional

50 Nasdaq securities, shall be phased-in

for compliance under the Order

Execution Rules.4 Furthermore, in

response to the Industry Letters, the

Commission is exempting responsible

brokers and dealers, electronic

communications networks, exchanges,

and associations, until April 14, 1997,

from the requirements of the ECN

Amendment with respect to all Nasdaq

securities not phased-in as of February

24, 1997, and from the requirements of

the Limit Order Display Rule with

respect to the 2350 Nasdaq securities

that will not be phased-in as of February

24, 1997. Under the prior schedule, all

Nasdaq securities would have been

phased-in by March 28, 1997 for

compliance with the requirements of the

ECN Amendment. Likewise, 850 of

these securities would have been

phased-in on February 28, and another

1500 on March 28, 1997, for compliance

with the Limit Order Display Rule.

The Commission believes it is

imperative to continue to phase-in

implementation of the Order Execution

Rules with respect to additional Nasdaq

securities. The Commission has granted

exemptive relief to monitor operation of

the rules carefully, and will develop a

further phase-in schedule for the

Nasdaq securities not phased-in as of

February 24, 1997.

The Commission finds that the

modifications of the compliance dates

described above, and the exemptive

relief provided herein to responsible

brokers and dealers, electronic

communications networks, exchanges,

and associations are consistent with the

public interest, the protection of

investors and the removal of

impediments to and perfection of the

mechanism of a national market system.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority, 17 CFR 200.30(a)(28), (61), and

(62).

Dated: February 5, 1997.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–3432 Filed 2–11–97; 8:45 am]

BILLING CODE 8010–01–M

17 CFR Part 240

[Release No. 34–38245; File No. S7–21–93]

RIN 3235–AF91

Reporting Requirements for Brokers or

Dealers Under the Securities Exchange

Act of 1934

AGENCY: Securities and Exchange

Commission.

ACTION: Final rule.

SUMMARY: The Securities and Exchange

Commission (‘‘Commission’’) is

amending its broker-dealer record

preservation rule to allow broker-dealers

to employ, under certain conditions,

electronic storage media to maintain

records required to be retained. The

amendments reflect a recognition of

technological developments that will

provide economic as well as time-saving

advantages for broker-dealers by

expanding the scope of recordkeeping

options while at the same time

continuing to require broker-dealers to

maintain records in a manner that

preserves their integrity. The

Commission is also issuing an

interpretation of its record preservation

rule relating to the treatment of

electronically generated

communications.

EFFECTIVE DATE: The amendments

become effective April 14, 1997.

FOR FURTHER INFORMATION CONTACT:

Michael A. Macchiaroli, Associate

Director (202/942–0132), Peter R.

Geraghty, Assistant Director (202/942–

0177) or Barbara A. Stettner, Staff

Attorney (202/942–0734), Division of

Market Regulation, Securities and

Exchange Commission, 450 Fifth Street,

NW., Mail Stop 5–1, Washington, DC

20549.

SUPPLEMENTARY INFORMATION

I. Introduction

On July 9, 1993, the Commission

issued a release (‘‘Proposing Release’’)

requesting comment on proposed

amendments to its broker-dealer record
6470 Federal Register / Vol. 62, No. 29 / Wednesday, February 12, 1997 / Rules and Regulations

1 17 CFR 240.17a–4. Rule 17a–4 sets forth the

records to be preserved by certain exchange

members, brokers, and dealers.

2Securities Exchange Act Release No. 32609 (July

9, 1993), 58 FR 38092 (July 15, 1993).

3Letter from Nelson S. Kibler, Assistant Director,

Division of Market Regulation, SEC to Robert F.

Price, Alex. Brown & Sons (November 3, 1979).

4Letter from Michael A. Macchiaroli, Associate

Director, Division of Market Regulation, SEC to

Michael D. Udoff, Chairman, Ad Hoc Record

Retention Committee, Securities Industry

Association (‘‘SIA’’) (June 18, 1993).

5 In response to these concerns, the Division’s noaction letter permitted optical storage of all paper

records, including handwritten records, except

those records required to be made under paragraphs

(a)(6) and (a)(7) of Rule 17a–3 (proprietary and

customer order tickets).

6The comment letters are available for public

inspection and copying in the Commission’s public

reference room located at 450 Fifth Street, NW.,

Washington, DC. (File No. S7–21–93).

7Ablative technology means that, by use of a

laser, a pattern is burned onto a metallic film on

an optical disk. Other methods of optical disk

technology utilize a laser to record information onto

the optical disk, but unlike ablative technology, the

laser does not necessarily ‘‘burn’’ a pattern onto the

disk.

8The SIA commented that optical tape provides

the same safeguards against data erasure and

manipulation as optical disk provides but allows for

storage of greater amounts of data. Letter from

Michael D. Udoff, Chairman, Ad Hoc Record

Retention Committee of the SIA to Jonathan G. Katz,

Secretary, SEC (September 30, 1993).

9Letter from Mark A. Egert, Assistant General

Counsel, SIA to Michael A. Macchiaroli, Associate

Director, Division of Market Regulation, SEC

(February 15, 1996) (arguing that CD–ROMs are

simply one of several different optical disk sizes

that are commercially available.)

10The Commission understands that additional

methods also available in a WORM, non-rewritable

version include, for example, alloying, bubbleforming, moth-eye (Plasmon), phase-change, dye/

polymer, and magneto-optic.

11The amendment the Commission is adopting

today also permits the use of ‘‘micrographic media’’

which is defined to include microfilm or

microfiche, or any similar media, which codifies an

earlier Commission staff no-action position. See

Letter from Nelson S. Kibler, supra note 3.

preservation rule, Rule 17a–4,1 that

would allow broker-dealers to employ,

under certain conditions, optical storage

technology.2 The proposed amendments

also would codify a staff no-action

position that allows broker-dealers to

use microfiche as a storage medium.3

Simultaneous with the issuance of the

Proposing Release, the Division of

Market Regulation (‘‘Division’’), with

the concurrence of the Commission,

issued a no-action letter allowing

broker-dealers to utilize optical storage

technology immediately, under certain

conditions.4 Based on the comments

received and the experience gained by

the Commission under the no-action

letter, the Commission is adopting the

proposed amendments with certain

changes discussed herein.

Set forth below is a summary of the

proposed amendments, a summary of

the comment letters received in

response to the Proposing Release, a

description of the final rule

amendments, and an interpretation

relating to the retention of electronically

generated communications. The

Commission is also providing notice of

a staff related no-action position

regarding other recordkeeping

requirements under the Securities

Exchange Act of 1934 (‘‘Exchange Act’’).

The Commission’s Proposal

The Commission proposed to amend

its record retention rule, Rule 17a–4, to

expand broker-dealer record retention

options by permitting broker-dealers to

use optical storage technology for

information required to be maintained

under these rules. The Proposing

Release described optical storage

technology as storage technology which

‘‘allows for digital data recording in a

non-rewriteable, non-erasable format,

such as write once, read many

(‘‘WORM’’) * * *. Non-rewriteable

optical storage records digital

information by employing a laser heat

source to burn a pattern on a metallic

film on a disk surface that can hold

billions of bytes of data.’’

In the Proposing Release, the

Commission noted the importance for

recordkeeping of ready access,

reliability, and permanence of records.

Therefore, the proposed rule included

safeguards against data erasure,

provisions for immediate verification of

the stored material, and requirements

for back-up facilities. Specifically, the

conditions included requirements that

broker-dealers using optical disk storage

systems employ non-rewriteable, nonerasable technology that verifies

automatically the quality and accuracy

of the optical storage recording process,

duplicate in a separate optical disk all

information preserved and maintained

by means of optical storage technology,

serialize the original and duplicate

optical disks, and time-date the

information placed on the optical disks.

In addition, to facilitate full access to

records during examinations by the selfregulatory organizations (‘‘SROs’’) and

the Commission, broker-dealers would

be required to index the optical disks

and place the index on optical disk, and

would be required to have the capability

to readily reproduce records kept on

optical disks in any medium acceptable

under the final rule amendment, as

required by the SROs and the

Commission.

The Proposing Release also solicited

comment regarding the adequacy of

optical disk technology to preserve

handwritten records or records that

contain handwritten text, given the

difficulties associated with detecting

alterations made to handwritten text

preserved through optical disk

technology.5

The Commission received 13

comment letters in response to the

Proposing Release.6 Several commenters

explained that the description of optical

storage technology in the Proposing

Release included only one specific type

of writing technology known as ablative

writing,7 and requested clarification that

the final rule would apply to other

forms of optical disk technology that

met the requirements of the rule. In

addition, a few commenters objected to

limiting the acceptable storage medium

to optical disk technology and

recommended that the rule apply to

other electronic storage media,

including optical tape.8 More recently,

the SIA requested clarification as to

whether the Commission considers CD–

ROM to be a form of optical disk

technology.9 Commenters that

addressed the issue of the adequacy of

optical disk technology in preserving

handwritten records or records that

contain handwritten text objected to any

restrictions on the types of records

broker-dealers can maintain using

optical storage technology.

II. Description of Rule Amendments

A. Scope of Permissible Electronic

Storage Media

In the Proposing Release, the

Commission did not intend the

definition of optical storage technology

to include only an ablative methodology

of storage. The Commission recognizes

that other methods of electronic storage

technology exist, including optical tape

and CD–ROM, which are available in a

WORM, non-rewriteable version.10 The

Commission is adopting a rule today

which, instead of specifying the type of

storage technology that may be used,

sets forth standards that the electronic

storage media must satisfy to be

considered an acceptable method of

storage under Rule 17a–4. Specifically,

because optical tape, CD–ROM, and

certain other methods of electronic

storage are available in WORM and can

provide the same safeguards against

data manipulation and erasure that

optical disk provides, the final rule

clarifies that broker-dealers may employ

any electronic storage media that meets

the conditions set forth in the final

rule.11

B. Handwritten Records

In the Proposing Release, the

Commission expressed concern and

requested comment regarding the use of

optical disk technology to preserve
Federal Register / Vol. 62, No. 29 / Wednesday, February 12, 1997 / Rules and Regulations 6471

12But see infra note 16 and accompanying text for

certain limited exceptions.

13Recently, the Commission published its views

with respect to the use of electronic media by

broker-dealers, transfer agents, and investment

advisers to deliver information as required under

the Exchange Act and the Investment Advisers Act

of 1940. Securities Exchange Act Release No. 37182

(May 9, 1996), 61 FR 24644 (May 15, 1996) (‘‘May

Interpretive Release’’). As the Commission noted in

the May Interpretive Release, the staff of the

Division also reminds broker-dealers, transfer

agents, and clearing agencies of their

responsibilities to prevent, and the potential

liability associated with, unauthorized transactions.

In this regard, broker-dealers, transfer agents, and

clearing agencies should have reasonable assurance

that information preserved by means of electronic

storage media, including customer signatures, is

authentic. See id. at note 29.

14See Letter from Michael D. Udoff, supra note

8.

15Another issue raised by several commenters

concerns the time at which the duplicate must be

created. Broker-dealers will be permitted to wait to

make the duplicate until the original optical disk

is full, provided that broker-dealers maintain the

duplicate data on another acceptable medium such

as paper or micrographic media until it creates the

duplicate optical disk.

handwritten records and records

containing handwritten text. As

indicated in the Proposing Release, the

Commission’s primary concern was

that, from the standpoint of

examinations and enforcement of the

securities laws, optical disk images (as

well as microfilm or microfiche images)

make it difficult to detect forgery and

alterations made to handwritten text.

The Commission recognizes that

microfilm is a form of record retention

for handwritten records that has been

permitted since 1970, and the

Commission understands few brokerdealers currently keep documents in

hard copy or paper format. The

Commission’s experience since 1970

relating to the retention of handwritten

records on microfilm has generally been

positive. The Commission further

understands that many of the larger

broker-dealers no longer create

traditional order tickets (with or without

handwritten notations) because such

broker-dealers enter most orders directly

through electronic systems which

automatically retain an electronic record

of the trade entry.

In view of the existing use of

microfilm and microfiche for record

retention, the Commission believes that

allowing preservation of handwritten

records in electronic storage media

would not significantly increase the

difficulty of detecting forgery or

alterations on these records.

Accordingly, the Commission is

permitting storage of handwritten

records and records containing

handwritten text using electronic

storage media meeting the requirements

set forth in the final rule adopted

today.12 Nonetheless, in the future, if

difficulties arise in detecting abuses in

handwritten records stored in electronic

format, the Commission may revisit this

issue both with regard to electronic

storage media, as well as microfilm and

microfiche.13

C. Creation of a Duplicate Record

The Proposing Release would have

required a broker-dealer to copy all of

the information contained on an original

disk onto a separate, duplicate disk. The

SIA commented that broker-dealers

should be permitted to store the

duplicate record on any medium

acceptable under Rule 17a–4. The SIA

explained that clearing firms frequently

have to provide copies of records to

their correspondent firms that may not

have optical disk technology. Therefore,

according to the SIA, clearing firms may

be obligated to maintain certain records

in another media for the

correspondents’ use.14 The Commission

agrees that it is appropriate to permit

storage of the duplicate record on any

medium acceptable under Rule 17a–4,

and accordingly, the final amendments

reflect this change.15

D. Audit System Requirement

The Proposing Release would have

required a broker-dealer to ‘‘have in

place an audit system providing for

accountability regarding all access to

records maintained and preserved using

optical storage technology and any

changes made to every original and

duplicate optical disk.’’ Commenters

sought clarification as to whether this

provision requires maintenance of a log

of all persons who have the capability

or authority to access optical disks, or

maintenance of a log indicating each

instance where data is added to a disk.

The rule adopted by the Commission

today requires an audit system to be

utilized only when records required to

be maintained under Rule 17a–4 are

being entered or when any additions to

existing records are made. Therefore, an

audit record is not required when a

record is accessed but cannot be altered

by the reader.

E. Third Party Down-Load Provider

The Proposing Release would require

broker-dealers to have arrangements

with at least one third party that has the

ability to download information from

the broker-dealer’s electronic storage

system to another acceptable medium.

The third party must submit

undertakings to the SRO for the brokerdealer indicating that it agrees to

promptly furnish information necessary

for the Commission’s staff and its

designees to download information from

a broker-dealer’s electronic storage

system to another acceptable medium,

and take reasonable steps to provide

access to information contained on a

broker-dealer’s electronic storage

system. The Commission is adopting

this requirement substantially as

proposed.

F. Escrow Agent

Under the Proposing Release, brokerdealers would be required to keep

current all information necessary to

download records and indices stored on

optical disks. Alternatively, brokerdealers who use outside service bureaus

to preserve records could place in

escrow and keep current a copy of the

information necessary to access the

format (i.e., the logical layout) of the

optical disks and to download records

stored on optical disks. This condition

was intended to ensure access to

information preserved on optical disks

when the broker-dealer is no longer

operational, when the broker-dealer

refuses to cooperate with investigative

efforts of the Commission or the SROs,

or when the optical disk has not been

properly indexed. The SIA commented

that they believed this requirement

duplicated the required third party

undertaking in the proposed

amendments. The third party

undertaking was intended to act as a

back-up to the escrow requirement, and

therefore the Commission does not agree

that it would be unnecessary and

duplicative to require broker-dealers to

keep or escrow the information

necessary to download records from

optical disk. Accordingly, the final rule

adopted today includes such proposed

requirement.

III. Staff No-Action Position

The Commission also is providing

notice that the staff of the Division will

not recommend enforcement action to

the Commission if broker-dealers,

transfer agents, and clearing agencies

fulfill their record retention and

preservation requirements set forth in

the following rules under the Exchange

Act by using electronic storage media as

permitted by the final amendments to

Rule 17a–4(f) described herein:

Rule 3a51–1 (17 CFR 240.3a51–1)

Rule 15a–6 (17 CFR 240.15a–6)

Rule 15c1–7 (17 CFR 240.15c1–7)

Rule 15c2–5 (17 CFR 240.15c2–5)

Rule 15c2–11 (17 CFR 240.15c2–11)

Rule 15c3–1 (17 CFR 240.15c3–1)

Rule 15c3–3 (17 CFR 240.15c3–3)

Rule 15g–3 (17 CFR 240.15g–3)

Rule 15g–4 (17 CFR 240.15g–4)

Rule 15g–5 (17 CFR 240.15g–5)
6472 Federal Register / Vol. 62, No. 29 / Wednesday, February 12, 1997 / Rules and Regulations

16 17 CFR 240.15g–2 and 240.15g–9.

17See May Interpretive Release at note 50.

18See id. at note 5. The Commission notes that

the New York Stock Exchange, Inc. (‘‘NYSE’’) has

submitted a proposal to modify its supervisory rules

which will require prior supervisory review of

those communications with the general public and

customers which include advertisements, market

letters, sales literature, and similar types of

communications, as well as research reports. The

proposal also requires members to develop

reasonable procedures for review of registered

representatives’ communications with the public

relating to their business. See File No. SR–NYSE–

96–26.

19Although Section 601(b) of the Regulatory

Flexibility Act defines the term ‘‘small entity,’’ the

statute permits agencies to formulate their own

definitions. The Commission has adopted

definitions of the term ‘‘small entity’’ for purposes

of Commission rulemaking in accordance with the

Regulatory Flexibility Act. Those definitions are set

forth in Rule 0–10, 17 CFR 240.0–10. See Securities

Exchange Act Release No. 18452 (January 28, 1982),

47 FR 5215 (February 4, 1982). A broker-dealer is

a ‘‘small business’’ or ‘‘small organization’’ under

Rule 0–10 if the broker-dealer (i) had total capital

(net worth plus subordinated liabilities) of less than

$500,000 on the date in the prior fiscal year as of

which its audited financial statements were

prepared pursuant to 17 CFR 240.17–5(d) or, if not

required to file such statements, a broker-dealer that

had total net capital (net worth plus subordinated

liabilities) of less than $500,000 on the last business

day of the preceding fiscal year (or in the time that

it has been in business, if shorter); and (ii) is not

affiliated with any person (other than a natural

person) that is not a small business or small

organization as defined in 17 CFR 240.0–10.

20 58 FR 42992 (August 12, 1993).

21 44 U.S.C. 3501 et seq.

22 61 FR 14586 (April 2, 1996).

Rule 15g–6 (17 CFR 240.15g–6)

Rule 17a–2 (17 CFR 240.17a–2)

Rule 17a–5 (17 CFR 240.17a–5)

Rule 17a–6 (17 CFR 240.17a–6)

Rule 17a–7 (17 CFR 240.17a–7)

Rule 17a–8 (17 CFR 240.17a–8)

Rule 17f–1 (17 CFR 240.17f–1)

Rule 17f–2 (17 CFR 240.17f–2)

Rule 17Ad–6 (17 CFR 240.17Ad–6)

Rule 17Ad–10 (17 CFR 240.17Ad–10)

Rule 17Ad–11 (17 CFR 240.17Ad–11)

Rule 17Ad–13 (17 CFR 240.17Ad–13)

Rule 17Ad–15 (17 CFR 240.17Ad–15)

The staff of the Division believes that

the recordkeeping requirements under

Exchange Act Rules 15g–2 and 15g–9 16

should not be met by means of

electronic storage media, and the

records required by such rules should

be maintained and preserved in paper

format for the prescribed time period.

Rules 15g–2 and 15g–9 require brokerdealers to obtain from a customer prior

to effecting transactions in penny stocks

(1) a manually signed acknowledgement

of the receipt of a risk disclosure

document, (2) a written agreement to

transactions involving penny stocks,

and (3) a manually signed and dated

copy of a written suitability statement.

Because the Commission, in the May

Interpretative Release, did not permit

the use of electronic media to satisfy the

requirements of Rules 15g–2 and 15g–9,

the staff of the Division believes it

would not be appropriate to permit the

storage of records required by such rules

using electronic storage media.17

IV. Electronic Communications

Finally, the Commission is aware that

many questions have been raised

regarding the applicability of Rule 17a–

4(b)(4) to electronic mail

communications (‘‘e-mail’’) and Internet

communications. In the May

Interpretive Release, the Commission

discussed its beliefs regarding the

adaptation of SRO supervisory review

requirements governing

communications with customers to

accommodate the use of electronic

communications by broker-dealers. The

Commission recommended that the

SROs work with broker-dealers with

respect to the adaptation of such rules

and recommended that the SRO rules

concerning the supervisory

requirements for electronic

communications ‘‘should be based on

the content and audience of the message

and not merely the electronic form of

the communication.’’ 18

The Commission understands that

broker-dealers use e-mail and the

Internet to communicate important

information relating to the brokerdealer’s business internally, to

customers, and to the general public.

The Commission is also aware that

many broker-dealers use such electronic

systems to communicate about issues

unrelated to the business of the brokerdealer. Consistent with the

Commission’s recommendation to the

SROs regarding the appropriate

standard for prior supervisory review

for electronic communications, the

Commission believes that for record

retention purposes under Rule 17a–4,

the content of the electronic

communication is determinative, and

therefore broker-dealers must retain

only those e-mail and Internet

communications (including inter-office

communications) which relate to the

broker-dealer’s ‘‘business as such.’’

V. Summary of Final Regulatory

Flexibility Analysis

The Regulatory Flexibility Act, which

became effective on January 1, 1981,

imposes procedural steps applicable to

agency rulemaking that has a

‘‘significant economic impact on a

substantial number of small entities.’’ 19

The Chairman of the Commission has

certified pursuant to the Regulatory

Flexibility Act that the final

amendments to Rule 17a–4 will not

have a significant economic impact on

a substantial number of small entities

because the amendments do not alter

the regulatory requirements for brokerdealers using currently accepted media

for record retention purposes (i.e.,

paper, microfilm, or microfiche). A copy

of the certification is attached to this

release as Appendix A.

VI. Paperwork Reduction Act

In connection with the Proposing

Release, on August 12, 1993, notice was

published in the Federal Register 20

that, pursuant to the Paperwork

Reduction Act of 1980 (‘‘Old PRA’’), 21

the Commission had submitted to the

Office of Management and Budget

(‘‘OMB’’) request for approval of the

proposed amendments to Rule 17a–4.

No comments were received with

respect to the notice. The OMB control

number, 3235–0279, was originally

issued in 1993 and was reauthorized on

June 30, 1996. Comment was sought

with respect to the reauthorization and

no comment was received. 22 The OMB

number was issued pursuant to the Old

PRA, prior to the amendment of such

act in 1995.

The Proposing Release included

certain requirements that would be

unique to broker-dealers which chose to

use optical storage systems and which

qualified as collections of information

under the Old PRA. The final rule

amendments do not contain substantive

modifications to the collections of

information originally set forth in the

Proposing Release. The collection of

information is in accordance with the

clearance requirements of 44 U.S.C.

3507. The final amendments clarify that

broker-dealers may use any electronic

storage media that meets the

requirements of the rule. Since the final

rule amendment expands the scope of

recordkeeping options and does not

alter the options currently permitted

under the rule, broker-dealers may

chose to continue to store information

using paper, microfilm, or microfiche,

or may chose to employ electronic

storage media as permitted by the final

rule amendments. If broker-dealers

chose the electronic storage media

option, then compliance with the

collection of information requirement is

mandatory.

A. Collection of Information Under Rule

17a–4

Under the final rule amendments,

users of electronic storage media must

have in place an audit system that

provides for accountability regarding

inputting of records required to be

maintained and preserved pursuant to
Federal Register / Vol. 62, No. 29 / Wednesday, February 12, 1997 / Rules and Regulations 6473

Rules 17a–3 and 17a–4 to electronic

storage media and inputting of any

changes made to every original and

duplicate record maintained and

preserved thereby. Although the

Commission is not specifying the

contents of each audit system, data

automatically or otherwise stored (in the

computer or in hard copy) regarding

inputting of records and changes to

existing records will be part of that

system. The Commission envisions that

names of individuals actually inputting

records and making particular changes,

and the identity of documents changed

and the identity of new documents

created, are the kind of information that

automatically would be collected

pursuant to the audit system

requirement. The results of the audit

system must be available for

examination by the staffs of the

Commission and the appropriate SROs

and must be preserved for the time

required for the audited records.

In addition, the entity employing the

electronic storage media must organize

and index all information maintained

on both original and duplicate

electronic storage media, and each

index must be duplicated. The entity

employing the technology must also

maintain, keep current, and provide

promptly upon request by the

Commission or SROs all information

necessary to access records and indexes

stored on electronic storage media, or

escrow and keep current a copy of the

physical and logical file format, the field

format of all different information types

written on the electronic storage media

and the source code, together with

appropriate documentation and

information necessary to access records

and indexes.

The recordkeeping requirements

described above are unlikely to prove

burdensome to users because the

recordkeeping requirements are

specifically tied to the design and use of

electronic storage media. To the extent

that the final rule amendments create

any burden on users, however, such

burden should be small, even negligible,

relative to the reduced recordkeeping

burden that will result from brokerdealers’ ability to use electronic storage

media.

B. Proposed Use of the Information

The information contained in the

records required to be preserved by

those subject to Rule 17a–4 will be used

by examiners and other representatives

of the Commission and the SROs to

ensure that broker-dealers are in

compliance with applicable financial

responsibility, antifraud, and

antimanipulation rules as well as other

rules and regulations of the Commission

and the SROs. The collections of

information generally will not be made

publicly available. The ultimate purpose

of the final amendment is the protection

of investors.

VII. Statutory Analysis

Pursuant to the Securities Exchange

Act of 1934 and particularly section

17(a)(1) thereof, 15 U.S.C. 78q(a)(1), the

Commission is adopting amendments to

§ 240.17a–4 of Title 17 of the Code of

Federal Regulations in the manner set

forth below.

List of Subjects in 17 CFR Part 240

Brokers, Reporting and recordkeeping

requirements, Securities.

Text of Final Rule

In accordance with the foregoing,

Title 17, chapter II, part 240 of the Code

of Federal Regulations is amended as

follows:

PART 240—GENERAL RULES AND

REGULATIONS, SECURITIES

EXCHANGE ACT OF 1934.

1. The authority citation for part 240

continues to read in part as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j,

77s, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c,

78d, 78f, 78i, 78j, 78k, 78k–1, 78l, 78m, 78n,

78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q,

79t, 80a–20, 80a–23, 80a–29, 80a–37, 80b–3,

80b–4 and 80b–11, unless otherwise noted.

* * * * *

2. Section 240.17a–4 is amended by

revising paragraph (f) to read as follows:

§ 240.17a–4 Records to be preserved by

certain exchange members, brokers and

dealers.

* * * * *

(f) The records required to be

maintained and preserved pursuant to

§§ 240.17a–3 and 240.17a–4 may be

immediately produced or reproduced on

‘‘micrographic media’’ (as defined in

this section) or by means of ‘‘electronic

storage media’’ (as defined in this

section) that meet the conditions set

forth in this paragraph and be

maintained and preserved for the

required time in that form.

(1) For purposes of this section:

(i) The term micrographic media

means microfilm or microfiche, or any

similar medium; and

(ii) The term electronic storage media

means any digital storage medium or

system and, in the case of both

paragraphs (f)(1)(i) and (f)(1)(ii) of this

section, that meets the applicable

conditions set forth in this paragraph (f).

(2) If electronic storage media is used

by a member, broker, or dealer, it shall

comply with the following

requirements:

(i) The member, broker, or dealer

must notify its examining authority

designated pursuant to section 17(d) of

the Act (15 U.S.C. 78q(d)) prior to

employing electronic storage media. If

employing any electronic storage media

other than optical disk technology

(including CD–ROM), the member,

broker, or dealer must notify its

designated examining authority at least

90 days prior to employing such storage

media. In either case, the member,

broker, or dealer must provide its own

representation or one from the storage

medium vendor or other third party

with appropriate expertise that the

selected storage media meets the

conditions set forth in this paragraph

(f)(2).

(ii) The electronic storage media must:

(A) Preserve the records exclusively

in a non-rewriteable, non-erasable

format;

(B) Verify automatically the quality

and accuracy of the storage media

recording process;

(C) Serialize the original and, if

applicable, duplicate units of storage

media, and time-date for the required

period of retention the information

placed on such electronic storage media;

and

(D) Have the capacity to readily

download indexes and records

preserved on the electronic storage

media to any medium acceptable under

this paragraph (f) as required by the

Commission or the self-regulatory

organizations of which the member,

broker, or dealer is a member.

(3) If a member, broker, or dealer uses

micrographic media or electronic

storage media, it shall:

(i) At all times have available, for

examination by the staffs of the

Commission and self-regulatory

organizations of which it is a member,

facilities for immediate, easily readable

projection or production of

micrographic media or electronic

storage media images and for producing

easily readable images.

(ii) Be ready at all times to provide,

and immediately provide, any facsimile

enlargement which the Commission or

its representatives may request.

(iii) Store separately from the original,

a duplicate copy of the record stored on

any medium acceptable under

§ 240.17a–4 for the time required.

(iv) Organize and index accurately all

information maintained on both original

and any duplicate storage media.

(A) At all times, a member, broker, or

dealer must be able to have such

indexes available for examination by the

staffs of the Commission and the self-
6474 Federal Register / Vol. 62, No. 29 / Wednesday, February 12, 1997 / Rules and Regulations

1Securities Exchange Act Release No. 32256 (May

4, 1993), 58 FR 27486 (May 10, 1993) (‘‘Concept

Release’’).

2Securities Exchange Act Release No. 33761

(March 15, 1994), 59 FR 13275 (March 21, 1994)

(‘‘Proposing Release’’).

3Letter from Brandon Becker, Division of Market

Regulation, SEC to Mary L. Bender, First Vice

President, CBOE and Timothy Hinkas, Vice

President, The Options Clearing Corporation

(‘‘OCC’’) (March 15, 1994) (‘‘1994 No-Action

Letter’’).

regulatory organizations of which the

broker or dealer is a member.

(B) Each index must be duplicated

and the duplicate copies must be stored

separately from the original copy of

each index.

(C) Original and duplicate indexes

must be preserved for the time required

for the indexed records.

(v) The member, broker, or dealer

must have in place an audit system

providing for accountability regarding

inputting of records required to be

maintained and preserved pursuant to

§§ 240.17a–3 and 240.17a–4 to

electronic storage media and inputting

of any changes made to every original

and duplicate record maintained and

preserved thereby.

(A) At all times, a member, broker, or

dealer must be able to have the results

of such audit system available for

examination by the staffs of the

Commission and the self-regulatory

organizations of which the broker or

dealer is a member.

(B) The audit results must be

preserved for the time required for the

audited records.

(vi) The member, broker, or dealer

must maintain, keep current, and

provide promptly upon request by the

staffs of the Commission or the selfregulatory organizations of which the

member, broker, or broker-dealer is a

member all information necessary to

access records and indexes stored on the

electronic storage media; or place in

escrow and keep current a copy of the

physical and logical file format of the

electronic storage media, the field

format of all different information types

written on the electronic storage media

and the source code, together with the

appropriate documentation and

information necessary to access records

and indexes.

(vii) For every member, broker, or

dealer exclusively using electronic

storage media for some or all of its

record preservation under this section,

at least one third party (‘‘the

undersigned’’), who has access to and

the ability to download information

from the member’s, broker’s, or dealer’s

electronic storage media to any

acceptable medium under this section,

shall file with the designated examining

authority for the member, broker, or

dealer the following undertakings with

respect to such records:

The undersigned hereby undertakes to

furnish promptly to the U.S. Securities and

Exchange Commission (‘‘Commission’’), its

designees or representatives, upon reasonable

request, such information as is deemed

necessary by the Commission’s or designee’s

staff to download information kept on the

broker’s or dealer’s electronic storage media

to any medium acceptable under Rule 17a–

4.

Furthermore, the undersigned hereby

undertakes to take reasonable steps to

provide access to information contained on

the broker’s or dealer’s electronic storage

media, including, as appropriate,

arrangements for the downloading of any

record required to be maintained and

preserved by the broker or dealer pursuant to

Rules 17a–3 and 17a–4 under the Securities

Exchange Act of 1934 in a format acceptable

to the Commission’s staff or its designee.

Such arrangements will provide specifically

that in the event of a failure on the part of

a broker or dealer to download the record

into a readable format and after reasonable

notice to the broker or dealer, upon being

provided with the appropriate electronic

storage medium, the undersigned will

undertake to do so, as the Commission’s staff

or its designee may request.

* * * * *

By the Commission.

Dated: February 5, 1997.

Margaret H. McFarland,

Deputy Secretary.

Note: Appendix A to the Preamble will not

appear in the Code of Federal Regulations.

Appendix A—Regulatory Flexibility Act

Certification

I, Arthur Levitt, Chairman of the Securities

and Exchange Commission, hereby certify

pursuant to 5 U.S.C. 605(b) that the final

amendments to Rule 17a–4 set forth in

Securities Exchange Release No. 34–38245

will not have a significant economic impact

on a substantial number of small entities.

Specifically, the amendments do not alter the

regulatory requirements for broker-dealers

using currently accepted media for record

retention purposes (i.e., paper, microfilm, or

microfiche). Instead, the amendments expand

the record retention media options by

allowing broker-dealers to utilize certain

electronic storage media to store records

required under 17 CFR 240.17a–3 and

240.17a–4. Accordingly, the amendments

will not change the impact of current

regulatory record preservation requirements

on a substantial number of small entities.

Dated: January 31, 1997.

Arthur Levitt,

Chairman.

[FR Doc. 97–3426 Filed 2–11–97; 8:45 am]

BILLING CODE 8010–01–P

17 CFR Part 240

[Release No. 34–38248; File No. S7–7–94]

RIN 3235–AG14

Net Capital Rule

AGENCY: Securities and Exchange

Commission.

ACTION: Final rule.

SUMMARY: The Securities and Exchange

Commission (‘‘Commission’’) is

amending Rule 15c3–1 under the

Securities Exchange Act of 1934

(‘‘Exchange Act’’), the net capital rule,

to permit broker-dealers to employ

theoretical option pricing models in

determining net capital requirements for

listed options and related positions.

Alternatively, broker-dealers may elect a

strategy-based methodology. The

amendments are intended to simplify

the net capital rule’s treatment of

options for capital purposes and more

accurately reflect the risk inherent in

broker-dealer options positions.

EFFECTIVE DATE: The amendments

become effective September 1, 1997.

FOR FURTHER INFORMATION CONTACT:

Michael A. Macchiaroli, Associate

Director (202) 942–0131, Peter R.

Geraghty, Assistant Director (202) 942–

0177, or Louis A. Randazzo, Special

Counsel (202) 942–0191, Division of

Market Regulation, Securities and

Exchange Commission, 450 Fifth Street,

N.W., Mail Stop 5–1, Washington, D.C.

20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

The Commission is adopting

amendments to Rule 15c3–1 under the

Exchange Act to permit broker-dealers

to employ theoretical option pricing

models to calculate required net capital

for listed options and the related

positions that hedge those options. In

adopting these amendments, the

Commission is continuing its process of

revising the net capital rule that was

contemplated when the Commission

solicited comments on a range of capital

related issues in 1993.1 The

amendments being adopted today were

proposed in initial form in March of

1994 and would allow broker-dealers to

use an options pricing model to

determine capital charges for listed

options and related positions.2

Simultaneously with the Commission’s

proposal, the Division of Market

Regulation (‘‘Division’’) issued a noaction letter allowing broker-dealers to

utilize the options pricing approach

immediately.3 Based on the experience

gained by the Commission under the noaction letter, and the nature of the

comments received during the public

comment period, the Commission is