[Federal Register Volume 63, Number 133 (Monday, July 13, 1998)]
[Rules and Regulations]
[Pages 37668-37688]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-18292]



[[Page 37667]]

_______________________________________________________________________

Part III





Securities and Exchange Commission





_______________________________________________________________________



17 CFR Part 240



Reports to be Made by Certain Brokers and Dealers and Year 2000 
Readiness Reports to be Made by Certain Transfer Agents; Final and 
Proposed Rules

Federal Register / Vol. 63, No. 133 / Monday, July 13, 1998 / Rules 
and Regulations

[[Page 37668]]



SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-40162; File No. S7-7-98]
RIN 3235-AH36


Reports to be Made by Certain Brokers and Dealers

AGENCY:Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
amending Rule 17a-5 under the Securities Exchange Act of 1934 
(``Exchange Act'') to require broker-dealers to file with the 
Commission and their designated examining authority (``DEA'') at 
designated times two separate reports regarding their Year 2000 
compliance. The reports will increase broker-dealer awareness that they 
should be taking specific steps now to prepare for the Year 2000; 
facilitate coordination with self regulatory organizations of industry-
wide testing, implementation, and contingency planning; supplement the 
Commission's examination module for Year 2000 issues and identify 
potential Year 2000 problems; and provide information regarding the 
securities industry's preparedness for the Year 2000. The reports are 
designed to be available to the public which will enable broker-dealer 
counterparties and others to assess the risks of doing business with a 
broker-dealer that may not be Year 2000 compliant.

EFFECTIVE DATE: August 12, 1998.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, 202/942-0131; Thomas K. McGowan, Assistant Director, 202/942-
4886; Lester Shapiro, Senior Accountant, 202/942-0757; or Christopher 
M. Salter, Staff Attorney, 202/942-0148, Division of Market Regulation, 
Securities and Exchange Commission, 450 Fifth Street, NW, Mail Stop 10-
1, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

    At midnight on December 31, 1999, unless the proper modifications 
have been made, the program logic in many of the world's computer 
systems will start to produce erroneous results because, among other 
things, the systems will incorrectly read the date ``01/01/00'' as 
being the year 1900 or another incorrect date. In addition, systems may 
fail to detect that the Year 2000 is a leap year. Problems can also 
arise earlier than January 1, 2000, as dates in the next millennium are 
entered into non-Year 2000 compliant programs.
    The Commission views the Year 2000 problem as an extremely serious 
issue. A failure to assess properly the extent of the problem, 
remediate systems that are not Year 2000 compliant, and then test those 
systems could endanger the nation's capital markets and place at risk 
the assets of millions of investors. In light of this, both the broker-
dealer industry and the Commission are working hard to address the 
industry's Year 2000 problems.
    As part of its ongoing efforts relating to the Year 2000, on March 
5, 1998, the Commission requested comment on proposed amendments to 
Rule 17a-5 \1\ that would require certain broker-dealers to file 
reports with the Commission and their DEA regarding Year 2000 
compliance.\2\ In particular, the Commission sought comment on: (i) the 
definition of the term ``Year 2000 Problem;'' \3\ (ii) the minimum net 
capital reporting threshold; (iii) the proposed reporting content; (iv) 
the requirement that portions of the report be attested to by 
independent public accountants; and (v) the public availability of the 
information to be reported.
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    \1\ 17 CFR 240.17a-5. Rule 17a-5 was adopted by the Commission 
pursuant to authority under Section 17 of the Exchange Act [15 
U.S.C. 78q], and particularly Section 17(e) [15 U.S.C. 78q(e)], 
which requires every broker- dealer to file annually with the 
Commission a certified balance sheet and income statement, and such 
officer information concerning its financial condition as the 
Commission may prescribe.
    \2\ Release Nos. 34-39724; IC-23059; IA-1704, (March 5, 1998), 
63 FR 12056 (March 12, 1998) (''Proposing Release'').
    \3\ The Proposing Release defined the term ``Year 2000 Problem'' 
to include any erroneous result caused by any computer software (i) 
incorrectly reading the date ``01/01/00'' or any year thereafter; 
(ii) incorrectly identifying a date in the year 1999 or any year 
thereafter; (iii) failing to detect that the Year 2000 is a leap 
year, and (iv) any other computer error that is directly or 
indirectly related to (i), (ii), or (iii) above.
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    The Commission received 35 comment letters in response to the 
Proposing Release.\4\ The majority of the commenters generally 
supported the Commission's proposals and made suggestions for improving 
one or more aspects of the proposed amendments.\5\ However, the 
majority of the commenters objected to the attestation requirement and 
the $100,000 minimum net capital threshold for determining which 
broker-dealers would be required to file Year 2000 reports under the 
proposed amendments. The majority of the commenters that addressed the 
issue of whether the information reported should be publicly available, 
objected to the Year 2000 reports and related accountant's attestation 
report being made public. Based on the comments received, the 
Commission is adopting the proposed amendments with the changes 
discussed below.
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    \4\ All comment letters are available in File No. S7-7-98 at the 
Commission's Public Reference Room, 450 Fifth Street, NW, 
Washington, DC 20549. The comment period closed on April 27, 1998. 
See also Release Nos. 34-39858; IC-23112; IA-1716 (extending the 
comment period from April 13, 1998 to April 27, 1998).
    \5\ Of the 35 comment letters received, five were opposed to any 
additional regulatory requirements.
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II. Description of the Proposed Rule Amendments

    Under the proposed amendments, a broker-dealer that is required to 
maintain minimum net capital of $100,000 or greater as of either 
December 31, 1997, or December 31, 1998, would have been required to 
file two reports at specified times with the Commission and its DEA 
regarding its efforts to address Year 2000 Problems. The first of these 
reports would have evaluated the efforts of the broker-dealer as of 
December 31, 1997, and would have been required to be filed no later 
than 45 days after the Commission adopted the proposed rule amendments. 
The second report would have evaluated the broker-dealer's efforts as 
of the date of its financial statements for fiscal year-end 1998. This 
report would have been required to be filed within 90 days after the 
date of its fiscal year-end financial statements.
    As part of the second report, each reporting broker-dealer would 
have been required to make assertions about its efforts to prepare for 
the Year 2000. For example, a broker-dealer would have been required to 
assert whether or not it has a plan to address Year 2000 Problems. In 
addition to making the assertions, each reporting broker-dealer would 
have been required to engage an independent public accountant to attest 
to whether there was a reasonable basis for the broker-dealer's 
assertions.\6\
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    \6\ The broker-dealer's assertions and the related accountant's 
attestation report would have been required to be filed only with 
the second report.
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    As noted in the Proposing Release, the Commission has advised 
broker-dealers that if a broker-dealer's computer systems have Year 
2000 Problems, the broker-dealer may be deemed not to have accurate and 
current records and be in violation of Rule 17a-3 under the Exchange 
Act.\7\ The Commission also reminded broker-dealers that Rule 17a-11 
under the Exchange Act requires every broker-dealer to promptly notify

[[Page 37669]]

the Commission of its failure to make and keep current books and 
records.\8\
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    \7\ 17 CFR 240.17a-3.
    \8\ 17 CFR 240.17a-11(d).
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III. Discussion of Final Rule Amendments

A. Reporting Threshold

    In the Proposing Release, the Commission proposed the $100,000 
minimum net capital reporting threshold because broker-dealers subject 
to this minimum net capital level are likely to have substantial 
financial exposure to the market and to customers. This threshold would 
have required all dealers, market makers, and clearing firms to file 
the Year 2000 reports.
    Several commenters, including the National Association of 
Securities Dealers (``NASD''), expressed concern about the proposed net 
capital threshold because that threshold excludes nearly 72% of all 
registered broker-dealers from reporting on their efforts to address 
Year 2000 Problems.\9\ These commenters stated that the Commission's 
proposal does not gather adequate information regarding the risks posed 
by the Year 2000 because the proposed threshold would exclude many 
firms that execute thousands of transactions each trading day effecting 
thousands of customers, market makers, and dealers. These commenters 
argued that the failure on the part of a large number of excluded 
broker-dealers to adequately prepare for the Year 2000 could have 
negative systemic effects on the world's financial markets.
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    \9\ As explained in the Proposing Release, under the proposed 
$100,000 net capital threshold, approximately 5,600 out of 7,800 
registered broker-dealers would be exempt from the Year 2000 
reporting requirements.
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    While mindful of the burden on small broker-dealers, the Commission 
is addressing this comment by requiring each broker-dealer with a 
minimum net capital requirement of $5,000 or greater to file reports 
with the Commission and with its DEA that discuss its efforts to 
address Year 2000 Problems. Broker-dealers that have a minimum net 
capital requirement of less than $100,000 will only be required to file 
a less burdensome check-the-box style Year 2000 report. Broker-dealers 
that meet a $100,000 minimum net capital reporting threshold will be 
required to file, in addition to the check-the-box report, a more 
detailed narrative discussion of their Year 2000 efforts. The format 
for broker-dealers to report on their efforts to address Year 2000 
Problems is discussed in more detail in paragraph III.F. below.

B. Attestation Requirement

    The Proposing Release would have required each broker-dealer to 
have an independent public accountant attest to several specific 
assertions included in the second Year 2000 report. The Commission 
believed it was important to have an independent third party affirm 
that there was a reasonable basis supporting the broker-dealer's 
assertions.
    As proposed, each broker-dealer would have been required to assert:
    (1) whether it has developed written plans for preparing and 
testing its computer systems for potential Year 2000 Problems;
    (2) whether the board of directors, or similar body, has approved 
these plans, and whether a member of the broker-dealer's board of 
directors, or similar body, is responsible for executing the plans;
    (3) whether its Year 2000 remediation plans address all domestic 
and international operations, including the activities of its 
subsidiaries, affiliates, and divisions;
    (4) whether it has assigned existing employees, hired new 
employees, or engaged third parties to execute its Year 2000 
remediation plans; and
    (5) whether it has conducted internal and external testing of its 
Year 2000 solutions and whether the results of those tests indicate 
that the broker-dealer has modified its software to correct Year 2000 
problems.
    The American Institute of Certified Public Accountants (``AICPA'') 
commented that the required attestation report would be difficult for 
independent public accountants to provide. The AICPA said that some of 
the required broker-dealer assertions are not appropriate for 
accountant attestation because the assertions are not capable of 
reasonably consistent measurement against reasonable criteria. 
Currently, there are no established criteria related to Year 2000 
remediation efforts. The lack of established criteria would likely 
result in significant variation in the examination procedures performed 
by independent public accountants and thus reduce the usefulness of the 
attestation reports. In addition, the AICPA expressed concern that the 
purpose and conclusions of the attestation report could be 
misunderstood. The AICPA was primarily concerned that uninformed users 
of the attestation reports would place undue reliance on them.
    The AICPA suggested that an ``agreed-upon procedures'' engagement, 
instead of an attestation engagement, would more effectively meet the 
Commission's goals. Pursuant to such an engagement, a broker-dealer 
would engage an independent public accountant to perform and report on 
specific procedures designed to meet the Commission's objectives. This 
would eliminate the variability of examination procedures performed by 
independent public accountants and thus increase the consistency of the 
reports received by the Commission. The AICPA's letter outlined 
elements of an agreed-upon procedures report and offered to follow-up 
with the Commission staff regarding the development of specific 
procedures for a Year 2000 engagement.
    The Commission is deferring consideration of whether to adopt a 
requirement that the second report be evaluated by an independent 
public accountant. The Commission, however, will consider such a 
requirement if the accounting industry recommends a standard which can 
be used by public accountants in connection with the second report.\10\
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    \10\ In light of the AICPA's comment letter and ongoing efforts, 
in a companion release also issued today the Commission is re-
opening the comment period with respect to the proposal to have an 
independent public accountant review a broker-dealer's second Year 
2000 report. The public file (No. S7-7-98) will include both the 
AICPA's original comment letter and any follow-up letter submitted 
by the AICPA for the Commission's consideration.
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C. Public Availability

    The proposed rules would have made a broker-dealer's Year 2000 
reports, including the attestation by the independent public 
accountant, available to the public. The Commission recognizes 
commenters' concerns that some users of these reports could place undue 
reliance on the reports, the technical nature of the reports could 
confuse investors, detailed testing reports could be misleading and 
unnecessarily alarming, and the reports could contain confidential 
proprietary information.
    However, the Commission believes that the public's interest is best 
served by requiring full and open disclosure. Allowing the public, 
particularly other broker-dealers and counterparties, to have access to 
the information reported by broker-dealers will enable interested 
persons to assess the Year 2000 readiness of a broker-dealer with which 
they are doing business. For example, after receiving a counterparty's 
report, another broker-dealer might request additional information or 
assurances if the counterparty does not appear to be taking the steps 
necessary to be Year 2000 compliant. In the absence of such assurances, 
the other broker-dealer could determine whether it wishes to

[[Page 37670]]

continue its dealings with that broker-dealer.
    Accordingly, the final rule provides that these reports will be 
available to the public.

D. Timing

    The Proposing Release established as-of dates and due dates for the 
reports broker-dealers were required to file.\11\ Some commenters 
explained that, in the absence of an existing requirement to make and 
retain records detailing Year 2000 remediation efforts as of December 
31, 1997, the information to prepare the reports may not be available. 
In addition, several commenters stated that reporting Year 2000 status 
as of December 31, 1997 would provide data that is outdated and 
misleading. Finally, some broker-dealers commented that they have 
fiscal years that end in mid to late 1998, and that the proposed due 
dates and as-of-dates for the first and second reports would have 
required some broker-dealers to file their reports virtually back-to-
back.
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    \11\ The first of these reports would have evaluated the efforts 
of broker-dealers as of December 31, 1997, and would have been 
required to be filed no later than 45 days after the Commission 
adopted the proposed rule amendments. The second report would have 
evaluated broker-dealer efforts as of the date of their financial 
statements for fiscal year-end 1998. This report would have been 
required to be filed within 90 days after the date of their 
financial statements.
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    The rule adopted by the Commission today requires a broker-dealer 
to file its first report with the Commission and its DEA by August 31, 
1998. This report should reflect the status of the broker-dealer's Year 
2000 efforts as of July 15, 1998. The second report must be filed with 
the Commission and the broker-dealer's DEA by April 30, 1999, and 
should reflect the status of the broker-dealer's Year 2000 efforts as 
of March 15, 1999.
    The rule adopted today also requires new broker-dealers who 
register as a broker-dealer between July 16, 1998 and December 31, 
1998, to file with the Commission and its DEA no later than 30 days 
after its registration becomes effective the first report on its Year 
2000 compliance as of the date of its registration. In addition, the 
rule also requires new broker-dealers who register as a broker-dealer 
between March 16, 1999 and October 1, 1999, to file with the Commission 
and its DEA no later than 30 days after its registration becomes 
effective a report on its Year 2000 compliance as of the date of its 
registration.\12\
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    \12\ New broker-dealers who register between January 1, 1999 and 
March 15, 1999, are required to file a report on their Year 2000 
efforts no later than April 30, 1999. This report should reflect 
their Year 2000 efforts as of March 15, 1999.
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E. Reporting Requirements

    As previously discussed, the Proposing Release would have required 
each reporting broker-dealer to discuss the steps it has taken to 
address Year 2000 Problems. More specifically, each broker-dealer would 
have been required to (i) indicate whether its board of directors, or 
similar body, has approved and funded written Year 2000 remediation 
plans that address all major computer systems; (ii) describe its Year 
2000 staffing efforts, and the work performed by Year 2000 dedicated 
staff; \13\ (iii) discuss its progress on each stage of preparation for 
the Year 2000; \14\ (iv) indicate if it has written contingency plans 
to deal with Year 2000 problems that may occur; \15\ and (v) identify 
what levels of management are responsible for Year 2000 remediation 
efforts.
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    \13\ This includes whether the broker-dealer has assigned 
existing employees, hired new employees, or engaged third parties to 
provide assistance in avoiding Year 2000 Problems.
    \14\ These stages are: (i) awareness of potential Year 2000 
Problems; (ii) assessment of what steps must be taken to avoid Year 
2000 Problems; (iii) implementation of the steps needed to avoid 
Year 2000 Problems; (iv) internal testing of software designed to 
avoid Year 2000 Problems; (v) integrated or industry-wide testing of 
software designed to avoid Year 2000 Problems (including testing 
with other broker-dealers, other financial institutions, customers, 
and vendors); and (vi) implementation of tested software that will 
avoid Year 2000 Problems.
    \15\ Contingency planning should provide for adequate 
protections to ensure the success of critical systems if interfaces 
fail or unexpected problems are experienced with operating systems 
and infrastructure software. In addition, contingency plans should 
provide for the failure of external systems that interact with the 
broker-dealer's computer system. For example, contingency plans 
should anticipate the failure of a vendor that services mission 
critical applications and should provide for the potential that a 
significant customer experiences difficulty due to Year 2000 
problems.
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    The Securities Industry Association (``SIA'') suggested some 
changes to the specific reporting requirements to better clarify the 
information sought by the Commission. For example, the Proposing 
Release would have required broker-dealers to discuss the work 
performed by Year 2000 dedicated staff on an individual basis. In 
addition, broker-dealers would have been required to identify the 
levels of management involved in the Year 2000 efforts, discuss the 
specific responsibilities of these managers, and provide an estimate of 
the time they have spent on Year 2000 efforts. The SIA explained that 
these proposed requirements may be very burdensome. Fixing Year 2000 
problems may require the dedicated efforts of a significant number of 
employees and consultants. In addition, the tasks and responsibilities 
involved may be detailed, extensive, and constantly changing.
    The proposed rule also would have required broker-dealers to report 
the number and nature of the exceptions resulting from both internal 
and integrated testing of software designed to avoid Year 2000 
Problems. The SIA commented that this requirement would likely provide 
meaningless information. The SIA explained that testing software is a 
dynamic process that in many instances requires exceptions to be 
identified hourly, daily, and weekly. In addition, identified 
exceptions may be immediately addressed, causing new exceptions to 
emerge. This process may repeat itself many times before testing is 
finished. Consequently, by the time the Commission received the Year 
2000 reports, the exceptions discussed in them may have been addressed 
and new exceptions identified.
    The Commission agrees that some modification of the reporting 
requirements is warranted. The rule adopted today requires each broker-
dealer completing the narrative portion of Form BD-Y2K to provide a 
summary of the efforts of Year 2000 dedicated individuals or groups of 
individuals. The broker-dealer will not have to provide an estimate of 
the time that its management has spent on Year 2000 efforts. Finally, 
the broker-dealer must report the number and description of material 
exceptions identified during the internal and external testing of its 
software that are unresolved as of the report date. The Commission is 
leaving the determination of what constitutes a material exception to 
the broker-dealer's judgment.

F. Report Format

    The Proposing Release would have required each broker-dealer 
meeting the $100,000 minimum net capital threshold to discuss, in 
narrative format, its efforts to address Year 2000 Problems. The 
National Association of Securities Dealers Regulation, Inc. (``NASDR'') 
commented that the Commission should prescribe a format for a broker-
dealer to use when reporting on its Year 2000 efforts. More 
specifically, the NASDR suggested that the Commission prescribe an 
objective reporting format, such as a check-the-box questionnaire. The 
NASDR explained that an open narrative format may lead to great 
disparity in the nature and detail of the reports that broker-dealers 
would submit. Providing a reporting format would produce consistent 
results, improve the accuracy and comparability of reports received, 
and reduce the time required to

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summarize, track, analyze, and report the information received.
    The Commission recognizes the value of receiving the requested 
information in an objective format and that prescribing such a format 
would decrease the burden that the Year 2000 reporting requirements 
impose on broker-dealers. However, the Commission also is concerned 
that limiting the reporting requirements to a check-the-box format for 
broker-dealers that pose the greatest risk to customers and the market 
will not provide the Commission or the DEAs sufficient information to 
effectively review for Year 2000 compliance.
    The rule the Commission adopts today requires each broker-dealer 
with a minimum net capital requirement of $5,000 or greater to file 
with the Commission and its DEA Part I of a new Form BD-Y2K.\16\ Part I 
of Form BD-Y2K is a check-the-box Year 2000 report that generally 
addresses the same issues the proposed narrative discussion addresses. 
Each broker-dealer that is required to maintain net capital of $100,000 
or greater will be required to file Part II of Form BD-Y2K, which 
requires a narrative discussion of its efforts to address Year 2000 
Problems. The narrative discussion is designed to provide the 
Commission and the DEA's with additional information on the Year 2000 
efforts of those broker-dealers who pose the greatest risk to customers 
and the market if they are not Year 2000 compliant.
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    \16\ For a copy of Form BD-Y2K see Attachment A.
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    Copies of Form BD-Y2K are available in Commission's Public 
Reference Room located at 450 Fifth Street, NW, Washington, DC 20549 or 
copies can be obtained from the Commission's internet web site at the 
following address: www.sec.gov.

IV. Costs and Benefits of the Rules and Their Effects on 
Competition, Efficiency, and Capital Formation

    Section 23(a) of the Exchange Act \17\ requires the Commission, in 
adopting rules under the Exchange Act, to consider the competitive 
effects of such rules and to not adopt a rule that would impose a 
burden on competition not necessary or appropriate in furthering the 
purposes of the Exchange Act. Furthermore, Section 3(f) of the Exchange 
Act \18\ provides that whenever the Commission is engaged in rulemaking 
and is required to consider or determine whether an action is necessary 
or appropriate in the public interest, the Commission also shall 
consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital formation.
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    \17\ 15 U.S.C. 78w (a)(2).
    \18\ 15 U.S.C. 78c.
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    The Commission has considered the amendments to Rule 17a-5 in light 
of the standards cited in Sections 3 and 23 (a)(2) of the Exchange Act. 
In the Proposing Release, the Commission requested that commenters 
provide analysis and data supporting the costs and benefits of the 
proposed amendments. In addition, the Commission sought comments on the 
proposed amendments' effect on competition, efficiency, and capital 
formation.
    Several commenters indicated that the Commission's cost estimates 
were too low. However, no commenters provided detailed information or 
data as to the costs of the proposed amendments. One commenter 
addressed the issue of whether the proposed amendments would affect 
competition. Finally, no comments were received regarding the proposed 
amendments effect on efficiency and capital formation.

A. Cost Benefit Analysis

    Based on comments received, the Commission has revised the proposed 
amendments the result of which is to lower the aggregate cost of 
compliance with the rule. As discussed above, the Commission is 
adopting new Form BD-Y2K and is expanding the requirement that a 
broker-dealer report on its Year 2000 efforts to each broker-dealer 
with a minimum net capital requirement of $5,000 or greater. Each of 
these broker-dealers is required to file Part I of Form BD-Y2K, a 
check-the-box Year 2000 report. Each broker-dealer that meets the 
$100,000 minimum net capital reporting threshold is required to also 
complete Part II of Form BD-Y2K.
    The Commission is also deferring consideration of whether to 
require broker-dealers to engage independent public accountants to 
examine their efforts to address Year 2000 Problems. The Commission is 
allowing broker-dealers to summarize by group the efforts of Year 2000 
dedicated individuals as opposed to requiring individual descriptions 
of these people's efforts. Broker-dealers will not have to provide an 
estimate of the time management has spent on Year 2000 efforts. 
Finally, broker-dealers are only required to report the number and 
description of unresolved material exceptions identified during the 
internal and external testing of their software.
    Based on field testing of Part I of Form BD-Y2K conducted by the 
Office of Compliance Inspections and Examinations, the Commission 
estimates that on average a broker-dealer will spend approximately two 
hours completing Part I of Form BD-Y2K resulting in a total cost to the 
industry of $2,400,000.\19\ This is based on 6,000 respondents spending 
four hours at $100 per hour preparing two reports consisting of Part I 
of Form BD-Y2K. The Commission estimates that on average a broker-
dealer will spend 35 hours completing Part II of Form BD-Y2K resulting 
in a total cost to the industry of $15,400,000. This is based on 2,200 
broker-dealers spending 70 hours at $100 per hour preparing two reports 
consisting of Part II of Form BD-Y2K. Therefore, based upon the 
adjustments to the proposed rule, the Commission has revised its cost 
to the industry to a total of $17,800,000 ($2,400,000 + $15,400,000). 
It is important to note that this is a total cost estimate and not an 
annual cost. Broker-dealers will only be required to prepare and file 
two Form BD-Y2Ks.
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    \19\ Field tests of Part I of Form BD-Y2K indicated that it 
could be completed in as little as 30 minutes. However, the 
Commission believes that it may take longer for some broker-dealers 
to complete Part I of Form BD-Y2K.
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    No commenters addressed the potential benefits of the amendments, 
and the Commission has not been able to quantify those benefits. 
However, the Commission believes that the benefits will outweigh the 
costs. The Commission is aware of the significant effort the securities 
industry has put forth and the progress it has made but believes that 
significant progress still needs to be made by the securities industry 
to be ready for the Year 2000.
    The Commission does not yet have comprehensive information 
regarding the readiness of the broker-dealer industry for the Year 
2000. Although the NASD and the NYSE have conducted surveys of their 
members, not all members responded to the survey and some of those who 
did submitted incomplete responses. It is important for the Commission 
to obtain complete information from individual broker-dealers to permit 
the Commission and Self Regulatory Organizations (``SROs'') to assess 
the risks associated with firms that fail to show adequate Year 2000 
progress. Moreover, the Commission believes that a regulatory 
requirement to file Year 2000 reports should encourage broker-dealers 
to proceed expeditiously with their efforts to prepare for the Year 
2000. The Commission will use the reported information to obtain a more 
complete understanding of the industry's overall Year 2000 preparations 
and to identify firm-specific and industry-wide problems. Information 
in the reports will help the

[[Page 37672]]

Commission focus its Year 2000-related efforts for the rest of 1998 and 
1999 on particular industry segments or firms that appear to pose the 
greatest risk of non-compliance.
    In sum, the rule amendments will enable the Commission to take a 
more active role in reducing the Year 2000 risk to the securities 
industry. The reports broker-dealers will be required to file will 
enable the Commission and the SROs to (i) better monitor the industry's 
Year 2000 readiness; (ii) increase broker-dealer awareness that they 
should be aggressively preparing for the Year 2000; (iii) coordinate 
industry-wide testing, implementation, and contingency planning; and 
(iv) enable the Commission to identify potential compliance problems.

B. Efficiency, Competition, and Capital Formation

    In the Proposing Release, the Commission stated that the proposed 
amendments should not unduly burden competition. One commenter 
addressed the proposed amendment's effect on competition. This 
commenter stated that the proposed amendments could have an 
anticompetitive effect because the amendments exclude nearly 72% of 
registered broker-dealers from having to report on their efforts to 
address Year 2000 Problems.
    The Commission has drafted the rule amendments so as to minimize 
their impact on competition. As discussed above, the Commission 
adjusted the proposed amendments to require each broker-dealer with a 
minimum net capital requirement of $5,000 or greater to report on its 
Year 2000 efforts in order to gather adequate information regarding the 
industry-wide risks posed by the Year 2000 Problem. However, the 
Commission has structured the form of the report to differentiate 
between broker-dealers based upon their size, type of business, and 
relative risk they pose to customers and the market if they are not 
Year 2000 compliant. Broker-dealers that do not meet the $100,000 
minimum net capital reporting threshold are only required to file the 
Year 2000 report. Broker-dealers that meet the $100,000 minimum net 
capital reporting threshold are required to provide additional 
information. The Commission believes that the proposed amendments do 
not impose any burden on competition not necessary or appropriate in 
furtherance of the Exchange Act.
    The Commission believes that the amendments should increase the 
efficiency and effectiveness of the industry's efforts to prepare for 
the Year 2000 by increasing awareness, focusing industry efforts, and 
providing critical information for identifying and remedying problems. 
In addition, the Commission believes that the amendments do not 
adversely affect capital formation. However, failure on the part of the 
securities industry to adequately prepare for the Year 2000 could 
adversely affect capital formation at the beginning of the next 
millennium.

V. Summary of Final Regulatory Flexibility Analysis

    A final Regulatory Flexibility Analysis (``FRFA'') concerning the 
amendments to Rule 17a-5 has been prepared in accordance with the 
provisions of the Regulatory Flexibility Act (``RFA''), as amended by 
Pub. L. 104-121, 110 Stat. 847, 864 (1996), 5 U.S.C. 604. The FRFA 
notes that the amendments to Rule 17a-5 will enable the Commission to 
(i) monitor the steps broker-dealers are taking to address Year 2000 
Problems; (ii) increase broker-dealer awareness that they should be 
taking specific steps now to prepare for the Year 2000; (iii) 
facilitate coordination with SROs on industry-wide testing, 
implementation, and contingency planning; and (iv) supplement the 
Commission's examination module for Year 2000 issues.
    The Commission received no comments on the Initial Regulatory 
Flexibility Analysis (``IRFA'') prepared in connection with the 
proposing release, and no comment letters specifically addressed the 
IRFA. However, as discussed in paragraphs III.A and IV.A above, certain 
commenters expressed concern about the threshold for determining which 
broker-dealers are required to report on their efforts to prepare for 
the Year 2000, and the estimated costs associated with obtaining the 
independent public accountant's attestation.
    As discussed more fully in the FRFA, the rule will affect small 
entities. When used with reference to a broker or dealer, the 
Commission has defined the term ``small entity'' to mean a broker or 
dealer (``small broker-dealer'') that: (1) 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 section 240.17a-5(d) or, if not required to file 
such statements, a broker or dealer that had total 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 (2) is not affiliated with any 
person (other than a natural person) that is not a small business or 
small organization as defined in this release.\20\
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    \20\ 17 CFR 240.0-10(c).
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    Based on FOCUS data for the fourth quarter of 1996, the latest 
information available, the Commission estimates that there are 
approximately 5,300 small broker-dealers. Of these 5,300 small broker-
dealers, approximately 3,800 are affected by the amendments to Rule 
17a-5.\21\
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    \21\ The proposed rule amendments would have affected 
approximately 600 small broker-dealers. The reasons for expanding 
the Year 2000 reporting requirements are discussed in paragraph 
III.A. above.
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    The Commission has drafted the rule amendments so as to minimize 
their impact on small broker-dealers while enhancing investor 
protection and minimizing any impact on competition, in part, by 
adopting different reporting requirements to take into account the 
resources available to small broker-dealers. The rule amendments 
require broker-dealers with a minimum net capital requirement of $5,000 
or greater to report on their efforts to address Year 2000 problems. 
However, approximately 1,500 small broker-dealers who do not have a 
minimum net capital requirement are exempt from reporting on their Year 
2000 efforts. In addition, the Commission has adopted two reporting 
formats for broker-dealers to use when reporting on their efforts to 
prepare for the Year 2000.
    Of the 3,800 small broker-dealers required to report on their Year 
2000 efforts, approximately 3,200 (84%) are only required to file a 
check-the-box style Year 2000 report. As noted in the cost-benefit 
section above, the Commission estimates that it would take each of 
these broker-dealers approximately 2 hours to complete the check-the-
box Year 2000 report. The remaining 600 (16%) small broker-dealers are 
required to provide, in addition to the check-the-box style report, a 
more extensive narrative discussion of their Year 2000 efforts because 
the type of business that these broker-dealers conduct poses a greater 
risk to customers and the market if they are not Year 2000 compliant. 
Thus, by adopting different reporting requirements and by exempting 
those broker-dealers who do not have a minimum net capital requirement, 
the Commission has imposed no burden, or only a very limited burden, on 
approximately 4,700 (89%) small broker-dealers.
    The FRFA notes that it would be difficult to further simplify, 
consolidate, or adjust compliance standards for small broker-dealers 
and be able to effectively monitor the securities industry's efforts

[[Page 37673]]

to prepare for the Year 2000. The Commission believes that the 
alternative reporting requirement adopted for small broker-dealers 
strikes the appropriate balance between the need to protect investors 
and the need to minimize the impact on small broker-dealers. The 
Commission also considered the use of performance rather than design 
standards. However, the Commission concluded that it would be 
inconsistent with the purpose of the rule to use performance standards 
to specify different requirements for small entities.
    A copy of the FRFA may be obtained by contacting Christopher M. 
Salter, Staff Attorney, U.S. Securities and Exchange Commission, Mail 
stop 10-1, 450 Fifth Street, NW., Washington, DC 20549.

VI. Paperwork Reduction Act

    As set forth in the Proposing Release, the amendments to Rule 17a-5 
contain collections of information within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\22\ Accordingly, the collection of 
information requirements were submitted to the Office of Management and 
Budget (``OMB'') for review and were approved by OMB which assigned the 
following control number 3235-0511.
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    \22\ 44 U.S.C. 3501 et seq.
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    The Proposing Release solicited comments on the proposed 
collections of information. No comments were received that specifically 
addressed the PRA submission. However, as discussed in sections III. 
and IV. above, the Commission received suggestions that would improve 
the collections of information. Based upon these suggestions, the 
collections of information have been adjusted as described in sections 
III. above and are in accordance with Section 3507 of the PRA.\23\ 
These adjustments include the adopting of two reporting formats to 
increase the consistency, accuracy and comparability of the information 
collected. In addition, the adjustments will reduce the time required 
to summarize, track, analyze, and report the information received.
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    \23\ 44 U.S.C. 3507.
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    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the agency displays a 
valid OMB control number. Broker-dealers are required to comply with 
the collection of information pursuant to the amendments to Rule 17a-5 
and the information is necessary to provide the Commission with a 
better understanding of the security industry's readiness for the Year 
2000. The information collected pursuant to the amendments to Rule 17a-
5 will be public.
    Based upon the adjustments to the amendments, the Commission is 
adjusting its burden estimate. The Commission estimated in the 
Proposing Release that, on average, a broker-dealer would spend 70 
hours preparing the Year 2000 report and obtaining the independent 
public accountant's Attestation. The Commission estimates that under 
the final amendments, a broker-dealer will, on average, spend two hours 
preparing Part I of Form BD-Y2K and 35 hours preparing Part II of Form 
BD-Y2K. The total annualized burden to the securities industry is 
estimated to be 89,000 hours. This is based on 6,000 respondents 
spending two hours preparing Part I and 2,200 respondents spending 35 
hours preparing Part II of Form BD-Y2K.

VII. Statutory Analysis

    Pursuant to the Securities Exchange Act of 1934 and particularly 
Sections 17(a) and 23(a) thereof, 15 U.S.C. 78o(c)(3) and 78w, the 
Commission is adopting amendments to Sec. 240.17a-5 of Title 17 of the 
Code of Federal Regulations in the manner set forth below.

List of Subjects in 17 CFR Parts 240 and 249

    Broker-dealers, 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, 77z-2, 77eee, 
77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k, 
78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d), 
78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 
80b-11, unless otherwise noted.
* * * * *
    2. By amending Sec. 240.17a-5 by adding paragraph (e)(5) to read as 
follows:


Sec. 240.17a-5  Reports to be made by certain brokers and dealers.

* * * * *
    (e) Nature and form of reports. * * *
    (5)(i) For purposes of this section, the term Year 2000 Problem 
shall include problems arising from:
    (A) Computer software incorrectly reading the date ``01/01/00'' as 
being the year 1900 or another incorrect year;
    (B) Computer software incorrectly identifying a date in the Year 
1999 or any year thereafter;
    (C) Computer software failing to detect that the Year 2000 is a 
leap year; or
    (D) Any other computer software error that is directly or 
indirectly caused by the problems set forth in paragraph (e)(5)(i)(A), 
(B), or (C) of this section.
    (ii) (A) No later than August 31, 1998, every broker or dealer 
required to maintain minimum net capital pursuant to Sec. 240.15c3-
1(a)(2) of $5,000 or greater as of July 15, 1998, shall file Part I of 
Form BD-Y2K (Sec. 249.618 of this chapter) prepared as of July 15, 
1998, and no later than April 30, 1999, every broker or dealer required 
to maintain minimum net capital pursuant to Sec. 240.15c3-1(a)(2) of 
$5,000 or greater as of March 15, 1999, shall file Part I of Form BD-
Y2K prepared as of March 15, 1999.
    (B) Every broker or dealer that registers pursuant to section 15 of 
the Act between July 16, 1998 and December 31, 1998 or between March 
16, 1999 and October 1, 1999, and that is required to maintain net 
capital pursuant to Sec. 240.15c3-1(a)(2) of $5,000 or greater, shall 
file Part I of Form BD-Y2K (Sec. 249.18 of this chapter) no later than 
30 days after its registration becomes effective. Part I of Form BD-Y2K 
shall be prepared as of the date its registration became effective.
    (iii)(A) No later than August 31, 1998, every broker or dealer with 
a minimum net capital requirement pursuant to Sec. 240.15c3-1(a)(2) of 
$100,000 or greater as of July 15, 1998 shall file Part II of Form BD-
Y2K (Sec. 249.618 of this chapter). Part II of Form BD-Y2K shall 
address each topic in paragraph (e)(5)(iv) of this section as of July 
15, 1998.
    (B) No later than April 30, 1999, every broker or dealer with a 
minimum net capital requirement pursuant to Sec. 240.15c3-1(a)(2) of 
$100,000 or greater as of March 15, 1999 shall file Part II of Form BD-
Y2K (Sec. 249.618 of this chapter). In addition, each broker or dealer 
subject to paragraph (e)(5)(iii)(A) of this section shall file Part II 
of Form BD-Y2K pursuant to this paragraph (e)(5)(iii)(B) regardless of 
its minimum net capital requirement. Part II of Form BD-Y2K shall 
address each topic in paragraph (e)(5)(iv) of this section as of March 
15, 1999.
    (C) Every broker or dealer that registers pursuant to section 15 of 
the Act between July 15, 1998 and December 31, 1998 or between March

[[Page 37674]]

16, 1999 and October 1, 1999, and that is required to maintain net 
capital pursuant to Sec. 240.15c3-1(a)(2) of $100,000 or greater, shall 
file Part II of Form BD-Y2K (Sec. 249.18 of this chapter) no later than 
30 days after registration becomes effective. Part II of Form BD-Y2K 
shall address each topic in paragraph (e)(5)(iv) of this section as of 
the effective date of its registration.
    (iv) Part II of Form BD-Y2K (Sec. 249.618 of this chapter) prepared 
pursuant to paragraph (e)(5)(iii) of this section shall identify a 
specific person or persons that are available to discuss the contents 
of the report and shall include a discussion of the following:
    (A) Whether the board of directors (or similar body) of the broker 
or dealer has approved and funded plans for preparing and testing its 
computer systems for Year 2000 Problems;
    (B) Whether the plans of the broker or dealer exist in writing and 
address all mission critical computer systems of the broker or dealer 
wherever located throughout the world;
    (C) Whether the broker or dealer has assigned existing employees, 
hired new employees, or engaged third parties to provide assistance in 
addressing Year 2000 Problems, and if so, a description of the work 
that these groups of individuals have performed as of the date of each 
report;
    (D) The current progress of the broker or dealer on each stage of 
preparation for potential problems caused by Year 2000 Problems. These 
stages are:
    (1) Awareness of potential Year 2000 Problems;
    (2) Assessment of what steps the broker or dealer must take to 
address Year 2000 Problems;
    (3) Implementation of the steps needed to address Year 2000 
Problems;
    (4) Internal testing of software designed to address Year 2000 
Problems, including the number and a description of the material 
exceptions resulting from such testing that are unresolved as of the 
reporting date;
    (5) Point-to-point or industry-wide testing of software designed to 
address Year 2000 Problems (including testing with other brokers or 
dealers, other financial institutions, and customers), including the 
number and a description of the material exceptions resulting from such 
testing that are unresolved as of the reporting date; and
    (6) Implementation of tested software that will address Year 2000 
Problems;
    (E) Whether the broker or dealer has written contingency plans in 
the event, that after December 31, 1999, it has problems caused by Year 
2000 Problems;
    (F) What levels of management of the broker or dealer are 
responsible for addressing potential problems caused by Year 2000 
Problems, including a description of the responsibilities for each 
level of management regarding the Year 2000 Problems;
    (G) Any additional material information concerning its management 
of Year 2000 Problems that will help the Commission and the designated 
examining authorities assess the readiness of the broker or dealer for 
the Year 2000.
    (v) The broker or dealer shall file an original and two copies of 
Form BD-Y2K (Sec. 249.618 of this chapter) prepared pursuant to 
paragraph (e)(5) of this section with the Commission's principal office 
in Washington, D.C. and one copy of Form BD-Y2K with the designated 
examining authority of the broker or dealer. The reports required by 
paragraph (e)(5) of this section shall be public.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

    3. The authority citation for part 249 continues to read in part as 
follows:

    Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;
* * * * *
    4. By adding Sec. 249.618 and Form BD-Y2K to read as follows.


Sec. 249.618  Form BD-Y2K, information required of broker-dealers 
pursuant to section 17 of the Securities Exchange Act of 1934 and 
Sec. 240.17a-5 of this chapter.

    This form shall be used by every broker-dealer required to file 
reports under Sec. 240.17a-5(e) of this chapter.

    Note: Form BD-Y2K does not appear in the Code of Federal 
Regulations. Form BD-Y2K is attached as Appendix A to this document.

    By the Commission.

    Dated: July 2, 1998.
Margaret H. McFarland,
Deputy Secretary.

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[FR Doc. 98-18292 Filed 7-10-98; 8:45 am]
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