Document ID: SEC-2018-1839-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2018-11-30T05:00Z

[Federal Register Volume 83, Number 231 (Friday, November 30, 2018)]
[Notices]
[Pages 61689-61692]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-26000]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-84646; File No. SR-FINRA-2018-039]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change Relating to 
FINRA Rule 4570 (Custodian of Books and Records)

November 26, 2018.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``SEA,'' ``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ notice is hereby given that on November 15, 2018, 
Financial Industry Regulatory Authority, Inc. (``FINRA'') filed with 
the Securities and Exchange Commission (``SEC'' or ``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by FINRA. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend FINRA Rule 4570 (Custodian of Books and 
Records) to: (1) Provide a member that is filing a Form BDW (Uniform 
Request for Broker-Dealer Withdrawal) the option of designating another 
FINRA member as the custodian of its books and records on the form; (2) 
clarify the obligations of the designated custodian; and (3) require 
the designated custodian to consent to act in such a capacity.
    The text of the proposed rule change is available on FINRA's 
website at http://www.finra.org, at the principal office of FINRA and 
at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    SEA Rule 17a-4 (Records to be Preserved by Certain Exchange 
Members, Brokers and Dealers) \3\ requires broker-dealers to retain 
their books and records for specified retention periods.\4\ Pursuant to 
SEA Rule 17a-4(g),\5\ a firm that stops doing business as a registered 
broker-dealer has a continuing obligation to retain its required books 
and records for the remainder of the specified retention periods. Form 
BDW requires that a firm that is withdrawing its registration identify 
and provide the contact information of the person who will have custody 
of the firm's books and records after the firm has discontinued its 
business operations. Form BDW also requires that the firm provide the 
address where the books and records will be located, if different than 
the custodian's address. In addition, the Form BDW provides that the 
firm and person signing the form on behalf of the firm must certify 
that the firm's books and records will be preserved and made available 
for inspection.
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    \3\ 17 CFR 240.17a-4.
    \4\ See also FINRA Rule 4511 (General Requirements).
    \5\ 17 CFR 240.17a-4(g).
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    FINRA Rule 4570 currently requires a member to designate as the 
custodian of its required books and records on the

[[Page 61690]]

Form BDW a person who is associated with the member at the time the 
Form BDW is filed.\6\ The rule is intended to enhance the ability of 
FINRA to obtain a firm's required books and records upon dissolution of 
the firm.\7\
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    \6\ For purposes of Rule 4570, an associated person is a natural 
person. See FINRA By-Laws, Article I, paragraph (rr).
    \7\ FINRA has jurisdiction over, and has the ability to obtain 
information from, a former associated person of a member for 
generally two years after: (1) The effective date of the person's 
termination of registration; (2) the effective date of revocation or 
cancellation of the person's registration; or (3) in the case of an 
unregistered person, the date upon which such person ceased to be 
associated with the member. See FINRA By-Laws, Article V, Section 4 
(Retention of Jurisdiction) and FINRA Rule 8210 (Provision of 
Information and Testimony and Inspection and Copying of Books).
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Permitting Another Member To Act as the Designated Custodian
    FINRA understands that some members have had difficulty in 
identifying and designating an associated person as the books and 
records custodian on their Form BDWs when they are in the process of 
winding down. These members have indicated that other members are 
willing to function as custodians for purposes of FINRA Rule 4570, but 
they cannot do so currently because of the limitations in the rule.
    To provide greater flexibility to members, FINRA is proposing to 
amend Rule 4570 to provide a member that is filing a Form BDW the 
option of designating another FINRA member as the custodian of its 
books and records on the Form BDW. The proposed rule change would not 
require members to designate another FINRA member as the custodian of 
their books and records, but would give them the option to do so, at 
their discretion. Firms would continue to have the option of 
designating an associated person as the custodian of their books and 
records. Further, the proposed rule change would preserve FINRA's 
ability to obtain the books and records of a former member because 
FINRA would continue to have jurisdiction over, and the ability to 
obtain information from, the member that has agreed to act as 
custodian.
Clarifying the Obligations of the Designated Custodian
    In addition to permitting another member to act as the designated 
custodian, FINRA is proposing to amend Rule 4570 to clarify the 
obligations of the designated custodian. Specifically, the proposed 
rule change would clarify that the custodian designated on the Form 
BDW, which would be either an associated person or another member, must 
preserve the books and records on behalf of the member that filed the 
Form BDW for the remainder of the applicable retention periods and make 
them available for inspection by FINRA upon request. For example, if a 
custodian receives a record from a firm that is going out of business 
that had an original retention period of six years, four years of which 
have already passed, the custodian must retain that record for the 
remaining two years and provide it to FINRA upon request.
    Further, the proposed rule change would clarify that a custodian is 
required to preserve and produce a former member's books and records in 
the same manner in which they were received. This provision is intended 
to ensure that the custodian does not alter the records after taking 
possession of them. However, the proposed rule change would provide 
that a custodian would not be precluded from converting the books and 
records in its possession into another format acceptable under the 
Exchange Act (e.g., convert from paper format to an electronic storage 
media), so long as such records are not altered or deleted during the 
conversion process.
    In addition, the proposed rule change would provide that where a 
member is acting as custodian, such member would not be required to 
verify the completeness or accuracy of the books and records that it 
receives. This exception is limited to members that are acting as 
custodians because their function is more akin to that of a 
recordkeeping service. However, FINRA believes that an associated 
person who is acting as custodian of a member's books and records is in 
a position to verify the completeness and accuracy of the member's 
books and records based on his or her existing relationship with the 
member.
    Finally, FINRA is proposing to amend Rule 4570 to require that 
where a FINRA member has agreed to act as custodian of the books and 
records of another member that has filed a Form BDW, the member acting 
as custodian must: (1) Treat such books and records as if they were its 
own books and records; and (2) arrange upon its dissolution for such 
books and records to continue to be retained for the remainder of the 
applicable retention periods under FINRA and Exchange Act rules in the 
same manner as its own books and records consistent with Rule 4570. 
FINRA believes that by clarifying the obligations of the custodian, the 
proposed rule change would facilitate compliance with the obligations 
under SEA Rule 17a-4(g) and Form BDW.
Requiring the Consent of the Designated Custodian
    FINRA has become aware of situations where the person named as the 
custodian on the Form BDW was not aware that the member was designating 
the person as a custodian. To address this issue, the proposed rule 
change would require a member to obtain the affirmative, written or 
verbal, consent of the custodian of books and records identified on the 
firm's Form BDW. In addition, the proposed rule change would require a 
member that is withdrawing its registration to inform its custodian of 
the obligations under FINRA and Exchange Act rules, including FINRA 
Rule 4570, prior to obtaining the custodian's consent.
    The proposed rule change would also require the designated 
custodian to represent to FINRA, in a method prescribed by FINRA, that 
the custodian: (1) Has consented to act in the capacity of a custodian; 
(2) understands the responsibilities of a custodian; and (3) agrees to 
provide the books and records of the member for which it is acting as 
custodian to FINRA upon request during the course of the required 
retention periods.
    The proposed rule change would impact all members, including 
members that have elected to be treated as capital acquisition brokers 
(``CABs'') and are subject to the CAB Rules. CAB Rule 457 subjects all 
CABs to FINRA Rule 4570. Accordingly, the proposed rule change to FINRA 
Rule 4570 would also impact CABs.
    If the Commission approves the proposed rule change, FINRA will 
announce the effective date of the proposed rule change in a Regulatory 
Notice to be published no later than 60 days following Commission 
approval. The effective date will be no later than 120 days following 
publication of the Regulatory Notice announcing Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\8\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the proposed rule change would 
facilitate compliance with FINRA and SEC recordkeeping requirements. 
Specifically, the proposed rule change

[[Page 61691]]

would provide a member the flexibility to select another member as its 
custodian, which would enhance FINRA's ability to obtain the member's 
required books and records upon the member's dissolution. This is 
because FINRA's jurisdiction over former associated persons is more 
limited than its jurisdiction over current members. The proposed rule 
change would also clarify the obligations of the designated custodian 
and require the designated custodian's consent, which would enhance the 
ability of designated custodians to carry out their recordkeeping 
responsibilities.
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    \8\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.
Economic Impact Assessment
    FINRA has undertaken an economic impact assessment, as set forth 
below, to further analyze the regulatory need for the proposed rule 
change, its potential economic impacts, including anticipated costs, 
benefits, and distributional and competitive effects, relative to the 
current baseline, and the alternatives FINRA considered in assessing 
how best to meet its regulatory objective.
Regulatory Need
    FINRA Rule 4570 is intended to ensure that a firm's books and 
records are properly retained and accessible for the remainder of the 
applicable retention periods after the firm withdraws its registration 
with FINRA. However, certain aspects of the rule as currently written 
limit a firm's ability to identify a willing custodian and reduce the 
likelihood that books and records are properly retained and accessible 
following a firm's termination of registration.
Economic Baseline
    The economic baseline for the proposed rule change is the number of 
firms that withdraw from the industry and thus file a Form BDW, and 
would therefore have to identify a custodian. In the past five years, 
approximately 1,100 firms filed a Form BDW, terminating their 
registration with FINRA. The firms had a median age of 14 years, and a 
median firm size of five associated persons and $240,000 in total 
assets, at the time they filed their Form BDW. The number of firms 
filing a Form BDW annually has largely remained constant over the last 
five years.\9\
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    \9\ Annually since 2013, FINRA has received a low of 212 
withdrawal requests (2014) and a high of 234 withdrawal requests 
(2013), and an average of 220 withdrawal requests per year.
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Economic Impact
    The proposed rule change would primarily affect firms filing a Form 
BDW, customers of those firms, designated custodians, and investors 
generally.
Benefits
    Currently, firms that file a Form BDW may only designate an 
associated person as the custodian of their books and records. By 
allowing such firms to designate another member as their custodian, the 
proposed rule change may reduce search costs associated with 
identifying a willing custodian. Search costs can be significant for 
firms filing a Form BDW as there are many other obligations that must 
also be addressed as a firm prepares to leave the industry. These 
obligations can make it difficult for a firm to identify an associated 
person who is willing, and able, to carry out the custodial 
responsibilities as the firm is in the process of winding down.
    FINRA believes that introducing-only firms with established 
relationships with clearing firms may be most likely to benefit from 
the additional flexibility provided in the proposed rule change.\10\ 
The clearing firm will already have possession of at least part of the 
introducing firm's books and records and, if willing to act in such a 
capacity, could therefore more easily maintain custody of all of the 
introducing firm's records along with its own books and records. The 
value of this flexibility would depend upon the willingness of the 
clearing firm to take on these custodial obligations after the 
introducing firm has left the industry. Any factor impacting the 
provision of clearing services more generally would likely also impact 
the likelihood that a clearing firm would be willing to take on the 
custodial responsibilities. Currently, there are approximately 1,479 
active introducing-only firms and 112 active clearing firms.\11\
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    \10\ Note that there are many firms that use clearing firms for 
some but not all of their transactions. The value of the additional 
flexibility decreases as the percentage of an introducing firm's 
records with any one clearing firm decreases.
    \11\ Of the 1,100 firms that withdrew from the industry over the 
last five years, we can affirmatively identify that 432 (39%) were 
introducing-only firms.
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    FINRA also believes that if a firm that is filing a Form BDW 
chooses another member as its custodian, it would enhance the ability 
of FINRA to obtain the books and records of the firm. This is because 
FINRA's jurisdiction over former associated persons is more limited 
than its jurisdiction over current members.\12\ As noted below, FINRA's 
ability to obtain the books and records of a former firm more easily 
and readily would also benefit customers of the firm and investors more 
generally.
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    \12\ FINRA has jurisdiction over, and has the ability to obtain 
information from, a former associated person generally for two 
years. See FINRA By-Laws, Article V, Section 4 (Retention of 
Jurisdiction) and FINRA Rule 8210 (Provision of Information and 
Testimony and Inspection and Copying of Books).
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    FINRA has become aware of situations where a document request was 
made to a custodian only to find that the custodian had stopped paying 
for the document storage or otherwise no longer had access to the books 
and records of the former firm. This makes books and records 
unavailable for use by FINRA staff, may inhibit the ability of FINRA 
staff to conduct its work and could lead to the imposition of sanctions 
on the custodian. Further, without access to the books and records of a 
former firm, customers who bring a claim against the firm may be 
limited in their ability to obtain restitution. Finally, FINRA and 
other regulators may be more limited in their ability to pursue a 
disciplinary action against the former firm or an associated person of 
the firm, possibly increasing risk to investors generally. By 
clarifying custodians' obligations, the proposed rule change aims to 
improve custodians' understanding of the time and monetary commitment 
and the potential sanctions that could be imposed on them should they 
not comply with their obligations.
    Further, FINRA has come across instances where the custodian was 
unaware that they were named as the custodian of a former firm's books 
and records and did not have access to them. By requiring the 
custodian's affirmative consent and representation to FINRA, the 
proposed rule change would eliminate such situations. Similar to the 
benefits associated with clarifying the obligations of custodians, the 
custodian's consent and representation to FINRA would also increase the 
likelihood that a former firm's books and records would be properly 
retained and accessible.
Costs
    The costs associated with the proposed rule change would likely 
depend on whether the designated custodian is an associated person or 
another member. The proposed rule change would give a firm that is 
filing a Form BDW the additional option of designating another member, 
rather than

[[Page 61692]]

an associated person, as its custodian. Therefore, the expansion of the 
categories of eligible custodians should impose no new burdens on firms 
that continue to designate associated persons as their custodians. 
Introducing firms that designate their clearing firms as custodians, 
subject to their consent, may incur additional costs associated with 
clearing services.
    Firms that designate members as their custodians, subject to their 
consent, may incur costs associated with record-keeping services 
provided by such members. For instance, a member that agrees to act as 
custodian is likely to incur operational and technology costs 
associated with integrating the former member's books and records into 
its record-keeping systems. Moreover, the proposed rule change could 
result in a change in how custodianship of books and records by firms 
leaving the industry is paid for and managed. For instance, clearing 
firms might adapt their business models to integrate the costs of 
custodial services into clearing agreements at the outset of the 
clearing relationship. This would potentially lead to an industry-wide 
increase in the costs of clearing agreements, regardless of any 
custodial undertaking by the clearing firms. However, considering the 
small number of firms that file Form BDW per year, FINRA believes that 
this is a low probability outcome.\13\ Further, the competitive 
dynamics of procuring clearing services may preclude this outcome, as 
firms that raise their fees may lose clients.
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    \13\ On average, 220 firms have filed a Form BDW each year over 
the last five years. This represents about five percent of all 
active firms.
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    The clarification of a custodian's obligations does not add any new 
direct burdens, but it could make it harder for firms to identify a 
custodian willing to agree to the obligations. Likewise, the 
affirmative consent requirement and the requirement to provide a 
representation to FINRA may make it more difficult for firms to find a 
willing custodian. However, given the importance to FINRA and investors 
of proper custody of books and records, FINRA believes that these 
additional burdens are warranted.
Alternatives Considered
    FINRA considered whether to amend Rule 4570 to require a firm that 
is going out of business to be only able to designate another member as 
its custodian. While such a requirement would further enhance FINRA's 
ability to obtain the books and records of former firms, FINRA 
determined that a firm that is leaving the industry and that is 
experiencing financial or operational difficulties may find it 
difficult to find another member that is willing to act as custodian. 
Further, FINRA continues to evaluate the viability that FINRA make 
itself available as an alternative custodian for members' records after 
withdrawal.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-FINRA-2018-039 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2018-039. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for website viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. Copies of such filing also will be available for inspection and 
copying at the principal office of FINRA. All comments received will be 
posted without change.
    Persons submitting comments are cautioned that we do not redact or 
edit personal identifying information from comment submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-FINRA-2018-039 
and should be submitted on or before December 21, 2018.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-26000 Filed 11-29-18; 8:45 am]
 BILLING CODE 8011-01-P