Source: https://www.sec.gov/rules/interp/34-44238.htm
Timestamp: 2019-04-24 10:40:15+00:00

Document:
SUMMARY: The Commission is publishing guidance on the operation of its rule permitting electronic storage of broker-dealer records in light of the recently enacted Electronic Signatures in Global and National Commerce Act of 2000. In particular, we are publishing guidance on how the electronic storage requirements of Rule 17a-4(f) under the Securities Exchange Act of 1934 meet, and are consistent with, the requirements of the Electronic Signatures in Global and National Commerce Act.
EFFECTIVE DATE: The guidance is effective on [Insert date of publication in the Federal Register].
FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate Director, 202/942-0131; Thomas K. McGowan, Assistant Director, 202/942-4886; Randall W. Roy, Special Counsel, 202/942-0798, or Mathew Comstock, Attorney, 202/942-0156, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-1001.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission ("Commission") is publishing guidance on how Rule 17a-4(f) (17 CFR 240.17a-4(f)) under the Securities Exchange Act of 1934 ("Exchange Act") is consistent with the Electronic Signatures in Global and National Commerce Act of 2000.
Since 1939, the Commission has required broker-dealers, through rules authorized under the Exchange Act, to make and maintain certain records deemed necessary to ensure compliance with federal securities laws and regulations.9 In 1997, after requests by industry representatives, the Commission amended its record retention rule to allow broker-dealers to store these records using any electronic storage medium, subject to certain requirements set forth in the rule.10 These requirements are safeguards designed to ensure the accuracy, accessibility, and accurate reproduction of the electronically stored records. The rule's evolution from a strictly paper requirement to its present electronic storage provisions reflects the Commission's approach of promoting the use of available technologies to the benefit of broker-dealers and investors.
In anticipation of the June 1, 2001 effective date for the electronic storage provisions of the Electronic Signatures Act, we are publishing this release to explain how the electronic storage requirements of the broker-dealer record retention rule meet, and are consistent with, the requirements of the Electronic Signatures Act.
Section 17(a)(1) of the Exchange Act authorizes the Commission to issue rules requiring broker-dealers to make and keep for prescribed periods, and furnish copies thereof, such records as necessary or appropriate in the public interest, for the protection of investors or otherwise in furtherance of the purposes of the Exchange Act.11 In 1939, the Commission adopted Rules 17a-3 (17 CFR 240.17a-3) and 17a-4 (17 CFR 240.17a-4), pursuant to this authority.12 Rule 17a-3 requires broker-dealers to make certain records, including trade blotters, asset and liability ledgers, income ledgers, customer account ledgers, securities records, order tickets, trade confirmations, trial balances, and various employment related documents.13 Rule 17a-4 specifies the manner and length of time that the records created in accordance with Rule 17a-3, and certain other records produced by broker-dealers, must be maintained.14 In combination, Rules 17a-3 and 17a-4 require broker-dealers to create, and preserve in an accessible manner, a comprehensive record of each securities transaction they effect and of their securities business in general. These rules impose minimum recordkeeping requirements that are based on standards a prudent broker-dealer should follow in the normal course of business. The requirements are an integral part of the investor protection function of the Commission, and other securities regulators, in that the preserved records are the primary means of monitoring compliance with applicable securities laws, including antifraud provisions and financial responsibility standards.
As mentioned, Rule 17a-4, when adopted in 1939, required broker-dealers to maintain records in paper form for the first two years of the specified retention period, and on microfilm thereafter.16 In 1970, the Commission amended the rule to allow the records to be stored immediately on microfilm.17 This amendment recognized that broker-dealers were increasingly using automated systems in their back office operations, and that the records generated on such systems could be transferred to microfilm more quickly than to paper, and at substantially less expense. As the Commission noted at the time, "the retention of reels of microfilm as against bulky hard copy records should enable an organization to effect substantial savings in storage space and man hours."18 The rule specifies certain requirements on the use of microfilm intended to "preserve the basic safeguards designed by [Rules 17a-3 and 17a-4] for the protection of public investors."19 Broker-dealers who use micrographic media must: (1) maintain facilities to protect the records and reproduce them in an easily readable format; (2) arrange the records and their indexes in a manner that permits the immediate location of a particular record; and (3) store a second copy of the records in a separate location.
In 1991, the Securities Industry Association ("SIA"), on behalf of its broker-dealer members, requested that the Division of Market Regulation ("Division") amend Rule 17a-4 to permit broker-dealers to store records electronically.20 The following year, the SIA requested that the Division not recommend enforcement action if broker-dealers stored records using an electronic storage technology known as optical disk.21 In its no-action request, the SIA set forth a list of safeguards that it believed were appropriate. These safeguards included that the storage system: be non-rewriteable and non-erasable (or write once, read many "WORM"); automatically verify the accuracy of stored information; serialize and time-date the records; and create indexes of the records. The SIA estimated that the savings realized by switching from microfilm to optical disk would range from $250,000 a year for a medium-sized firm to $1.6 million a year for a large firm.
In 1993, the Division issued a no-action letter in response to the SIA's 1992 request. The no-action letter permitted broker-dealers to meet the record retention requirements of Rule 17a-4 using optical disk storage technology.22 This allowed broker-dealers to take advantage of the savings and of the increased productivity and quicker access to archived records provided by optical disk. At the same time, the Division recognized that the use of an electronic storage system raised audit and examination concerns. Consequently, the Division established certain conditions for using optical disk to help ensure that records stored in this manner would be accurate and accessible for examination purposes. These conditions were consistent with the safeguards proposed by the SIA in its 1992 no-action request. For example, the optical disk technology stores digital information by employing a laser heat source to burn a pattern on the disk, which makes the records non-rewriteable and non-erasable. The letter also required: (1) broker-dealers to file an undertaking signed by a third-party in which the third-party represents that it will access the records at the request of the Commission; (2) the optical disk system to automatically verify the quality and accuracy of the recording process; (3) the optical disk system to serialize the original and any duplicate units of the storage medium and time-date information stored on the medium; and (4) the optical disk system to have the capacity to download indices and records.
The Electronic Signatures Act does not specify the conditions under which an electronic record would be deemed to have met these requirements. However, it does preserve the ability of regulatory agencies to interpret them with respect to statutes under which they have rulemaking authority.26 The exercise of this interpretive authority is subject to certain guidelines. First, the interpretation must be "consistent" with Section 101 of the Act.27 Second, the interpretation may not "add to the requirements" of Section 101.28 Third, the agency, in issuing the interpretation, must find that: (1) there is substantial justification for the interpretation; (2) the methods selected to carry out that purpose are substantially equivalent to the requirements imposed on records that are not electronic; (3) the methods selected to carry out that purpose will not impose unreasonable costs on the acceptance and use of electronic records; and (4) the methods selected to carry out that purpose do not require, or accord greater legal status or effect to, the implementation or application of a specific technology or technical specification.29 We believe the electronic storage requirements of Rule 17a-4(f) meet these guidelines.
The electronic storage requirements of Rule 17a-4(f) are consistent with Section 101(d) of the Electronic Signatures Act. First, the Electronic Signatures Act provides that statutes or regulations requiring the retention of certain contractual or transactional records may be complied with by storing them electronically. Rule 17a-4(f) allows for the retention of documents in electronic form. In fact, the rule is broader than the Electronic Signatures Act because it does not limit its applicability to contracts or other records that relate to transactions in or affecting interstate or foreign commerce. Rather, it permits broker-dealers to electronically store all records they are required to retain under Rule 17a-4. Moreover, Rule 17a-4(f) makes specific provision for the use of new technologies as they become available, which is consistent with the technology-neutral requirements in the Electronic Signatures Act.
The electronic storage requirements of Rule 17a-4(f) do not add to the requirements of Section 101(d) of the Electronic Signatures Act. The Electronic Signatures Act requires electronic records to be stored in a manner that ensures they are accurate, accessible, and capable of being accurately reproduced for later reference. Rule 17a-4(f) permits broker-dealers to store electronic records in a manner consistent with the Electronic Signatures Act. For example, the WORM requirement is designed to ensure that electronic records are capable of being accurately reproduced for later reference by maintaining the records in an unalterable form. The automatic verification requirement is designed to ensure the records are accurate by providing verification that a record has been accurately stored in the electronic system. Indexing is designed to ensure that the records are accessible by providing a means to search for specific records among the many that have been stored. The third-party download requirement is designed to ensure that records remain accessible by providing that a person with the appropriate knowledge and expertise will access the system at the Commission's request. The serialization provision is intended to ensure both the accuracy and accessibility of the records by indicating the order in which records are stored, thereby making specific records easier to locate and authenticating the storage process.
The electronic storage requirements of Rule 17a-4(f) are substantially justified by the need to protect investors and ensure the soundness of the securities markets. Over the last several years, there has been significant growth in the number of investors entering these markets. For example, we estimate that the number of securities accounts at U.S. broker-dealers has grown from approximately 35 million in 1990 to 82 million in 1999. In part, this growth has been driven by advances in information and trade processing technology, which make it easier for investors to purchase and hold securities. The increase in the number of investors has emphasized the need for a safe and sound market place.
The Commission is responsible for interpreting and enforcing federal securities laws and regulations - such as anti-fraud, sales practice and financial responsibility requirements - aimed at ensuring safe and sound securities markets. Because broker-dealers play a critical role in these markets, the Commission has established rules requiring them to act in a manner that foremost is protective of the interests of their customers and other market participants. These rules, along with rules promulgated by the self-regulatory organizations ("SROs"), seek to ensure that broker-dealers operate in a financially sound manner, maintain adequate custody of customer assets, and refrain from deceptive and manipulative practices. To monitor compliance with these rules, the Commission requires broker-dealers to make and maintain records that document their transactions with customers and overall securities operations. Commission and SRO examiners review these records to determine whether broker-dealers are acting within the requirements of the securities laws, regulations and SRO rules. Accordingly, if investors are to be adequately protected, regulators must be able to rely on these records as providing a true account of a broker-dealer's operations.
Moreover, the complexity of the securities business makes accurate and comprehensive recordkeeping vital to the financial well being of broker-dealers and, as a result, investors and the securities markets. Many securities firms process large volumes of transactions on a daily basis across diverse markets, business groups and geographic areas. Each trade generates several separate records that must be retained. In addition, broker-dealers hold cash and a wide range of domestic and foreign securities on behalf of their customers. The amount of securities under a firm's control constantly changes as it effects transactions. Moreover, the securities for which a broker-dealer has custodial responsibility are frequently maintained in different locations throughout the world. This complexity of operations makes the accurate and comprehensive keeping of broker-dealer books and records crucial to the securities industry. A failure to maintain accurate, accessible, and true records may lead to situations where a firm cannot account for customer property or its own assets. For these reasons, the Commission's broker-dealer recordkeeping requirements are an important part of managing systemic risk in the industry.
The electronic storage requirements of Rule 17a-4(f) are intended to ensure the prompt production of legible, true, and complete records, a requirement applicable to the storage of all broker-dealer records regardless of their form. Accordingly, the requirements for electronic storage are substantially equivalent to the requirements for the other methods of record storage.
These requirements apply regardless of whether the records are stored in paper form, on micrographic media, or using electronic media. However, given the differences in the methods of storage, the rule sets forth, with respect to micrographic and electronic media, certain requirements designed to ensure the prompt production of legible, true, and complete records. These requirements do not impose greater burdens on broker-dealers for using micrographic or electronic storage methods; rather, they address the unique characteristics of each storage method and seek to put them all on an equal footing. For example, the ability to promptly produce legible, true, and complete paper records requires keeping them in an accessible location and filed in a way that particular documents can be identified and retrieved. Conversely, it is not enough to simply keep microfilm tapes or optical disks easily accessible. There must also be facilities to locate the appropriate records, to read them, and to print them. Therefore, paragraph (f) of Rule 17a-4 specifies that broker-dealers using micrographic or electronic media must have such retrieval facilities available.38 Requiring such facilities for electronically stored records is similar to requiring that paper records be in an accessible place. Moreover, the indexing requirement for records stored using micrographic or electronic media allows for the retrieval of specific records in a manner equivalent to the way that particular paper records can be pulled from designated files.
Furthermore, paper and micrographic media both store exact images of the information as it was originally entered into the record. Electronic media, on the other hand, store the original information in digital or computerized form. The WORM provision is designed to ensure that the original information is preserved in an unalterable manner so that it can be accurately reproduced for later reference.
Paper records are accessible if examiners can obtain and use them. In contrast, accessing electronic storage media systems requires varying degrees of technical expertise (depending on the medium used) and, very likely, knowledge of the proprietary characteristics (e.g., passwords and source codes) of a given system. Therefore, Rule 17a-4(f) requires an undertaking that a third party can provide access to these records. In the absence of such an undertaking, examiners could find it difficult, if not impossible, to obtain electronic records from a broker-dealer that had gone out of business or was refusing to cooperate. Consequently, attempting to retrieve records from an electronic storage medium without the requisite technological knowledge would be no different than attempting to obtain records from a broker-dealer that stored paper records in an inaccessible place.
The costs associated with the electronic storage requirements of Rule 17a-4(f) are reasonable, given their investor protection objective and goal of reducing storage expenses. Broker-dealers have had the option since 1993 of storing records electronically on optical disk, and since 1997 on any type of electronic media. The requirements for using electronic storage media (e.g., WORM, automatic verification, indexing, third-party undertaking) have been in place since the Division's 1993 no-action letter. Our interpretation today does not add to these requirements, and therefore, will not increase the costs of electronic storage, which have likely decreased since 1993 and should continue to drop as technological advances occur. Moreover, the costs of storing large volumes of records electronically are likely to be substantially lower than storing them on paper or on micrographic media.
We believe the electronic storage requirements in Rule 17a-4(f) are necessary to ensure the accuracy, accessibility, and accurate reproduction of broker-dealer records stored electronically. Accordingly, we believe they are reasonable, particularly when measured against the problems that could arise if the ability of securities regulators to enforce compliance with securities laws and regulations was compromised due to inadequate and unreliable electronic recordkeeping. Moreover, as discussed in the next section, the requirements are technology-neutral and, therefore, allow for the use of new technologies as they become available. This flexibility is incorporated in the rule to keep record retention costs as low as possible.
The Commission also acknowledged that, with respect to the WORM provision, several storage methodologies, in addition to the ablative method mentioned above, were available.42 For these reasons, the electronic storage requirements of Rule 17a-4 do not require, or accord greater legal status to, the implementation or application of a specific technology or technical specification.
Even if the electronic storage requirements of Rule 17a-4(f) accorded greater legal status to the implementation or application of a specific technology or technical specification, the requirements would still be permissible under the Electronic Signatures Act. The Electronic Signatures Act contains an exception to the limitation against the implementation or application of a specific technology or technical specification.43 The exception permits an agency to specify performance standards to ensure the accuracy, accessibility, and integrity of records that are required to be retained, even if those standards require implementation or application of a specific technology or technical specification. Under the Electronic Signatures Act, such performance standards must: (1) serve an important governmental objective; and (2) be substantially related to the achievement of that objective.44 Even if the electronic storage requirements of Rule 17a-4(f) must be evaluated under Section 104(b)(3)(A) of the Electronic Signatures Act, they serve an important governmental objective and are substantially related to achieving that objective.
The electronic storage requirements are designed to ensure that the Commission can promptly obtain legible, true, and complete records. Because the Commission relies on this ability to fulfill its responsibilities, the requirements are substantially related to the Commission's regulatory function. The Commission, in the release adopting the electronic storage requirements of Rule 17a-4, noted the "importance for recordkeeping of ready access, reliability, and permanence of records." 48 Therefore, the release made clear that the electronic storage requirements were intended as "safeguards against data erasure" and to "facilitate full access to the records during examinations."49 As noted by Senator Leahy, the Electronic Signatures Act specifically authorizes agencies "to set performance standards to assure the accuracy, integrity, and accessibility of records that are required to be retained."50 Statements of Senators Hollings, Wyden and Sarbanes, and of Representative Dingell indicate that the intent behind this section of the Electronic Signatures Act was to allow agencies to have standards designed to, among other things, prevent companies from retaining materials in an easily alterable form.51 The electronic storage requirements of Rule 17a-4(f), such as WORM, are designed for this purpose.
For the foregoing reasons, we find that the electronic storage requirements of Rule 17a-4(f) meet, and are consistent with, the requirements of the Electronic Signatures Act.
1. Part 241 is amended by adding Release No. 34-44238 and the release date of May 1, 2001 to the list of interpretive releases.
1 Pub. L. No. 106-229, 114 Stat. 464 (2000).
2 Electronic Signatures Act § 101(a).
3 Electronic Signatures Act § 101(d)(1).
5 Electronic Signatures Act § 104(b).
6 Electronic Signatures Act § 107(b)(1).
7 Electronic Signatures Act § 107(b)(1)(B).
8 Exchange Act Release No. 44014 (Feb. 28, 2001), 66 FR 13273 (March 5, 2001), http://www.sec.gov/news/digest.shtml.
9 Exchange Act Release No. 2304 (Nov. 13, 1939), 4 FR 4578 (Jan. 2, 1940).
10 Exchange Act Release No. 38245 (Feb. 5, 1997), 62 FR 6469 (Feb. 12, 1997) ("Adopting Release").
12 Exchange Act Release No. 2304 (Nov. 13, 1939), 4 FR 4578 (Jan. 2, 1940).
15 The Commission continues to be interested in exploring ways in which technology can be used to create efficiencies without sacrificing the Commission's regulatory objectives.
16 Exchange Act Release No. 2304 (Nov. 13, 1939), 4 FR 4578 (Jan. 2, 1940).
17 Exchange Act Release No. 8875 (Apr. 30, 1970), 35 FR 7644 (May 16, 1970).
20 Letter from Edward I. O'Brien, President, SIA, to William Heyman, Deputy Director, Division, (May 1, 1991).
21 Letter from Michael D. Udoff, Chairman, Ad Hoc Record Retention Committee, SIA, to Michael Macchiaroli, Assistant Director, Division, (May 19, 1992).
22 Letter from Michael A. Macchiaroli, Associate Director, Division, to Michael D. Udoff, Chairman, Ad Hoc Record Retention Committee, SIA (June 18, 1993).
23 Adopting Release 34-38245, 62 FR 6469 (Feb. 12, 1997).
24 The requirements for using electronic storage media for broker-dealer records are set forth in subsections (2)(i), (2)(ii)(A) - (D), and (3)(i) - (vii) of paragraph (f) of Rule 17a-4. These subsections are the requirements that are generally referred to throughout this release as, among other terms, "the electronic storage requirements of Rule 17a-4(f)."
25 Electronic Signatures Act § 101(d)(1).
26 Electronic Signatures Act § 104(b).
27 Electronic Signatures Act § 104(b)(2)(A).
28 Electronic Signatures Act § 104(b)(2)(B).
29 Electronic Signatures Act § 104(b)(2)(C).
30 See 66 FR 13273 (March 5, 2001).
31 We also note that, during the debate on the Electronic Signatures Act, a concern was raised as to whether the validity of a contract could be challenged because it was not retained in an accurate or accessible manner. 146 Cong. Rec. H4349 (daily ed. June 14, 2000) (statement of Rep. Dreier). The electronic storage requirements of Rule 17a-4(f) are designed to ensure that electronic records are kept in an accurate and accessible manner.
32 146 Cong. Rec. H4347 (daily ed. June 14, 2000) (statement of Rep. Sessions).
33 Adopting Release, 62 FR at 6469.
34 146 Cong. Rec. H4358 (daily ed. June 14, 2000) (statement of Rep. Dingell) (emphasis added).
35 Electronic Signatures Act § 104(b)(2)(C).
36 See e.g., In the Matter of Del Mar Financial Services, Inc., et al., Exchange Act Release No. 42421 (Feb. 14, 2000); In the Matter of A.S. Goldmen & Co., Inc., et al., Exchange Act Release No. 41601 (July 7, 1999).
38 17 CFR 240.17a-4(f)(3)(i) and (ii).
39 Exchange Act Release No. 32609 (July 9, 1993), 58 FR 38092 (July 15, 1993).
40 Adopting Release, 62 FR 6469.
41 Adopting Release, 62 FR at 6470.
42 Adopting Release, 62 FR at 6470 n.10 (The other methodologies identified in the release were alloying, bubble-forming, moth-eye (Plasmon), phase-change, dye/polymer, and magneto-optic.).
43 Electronic Signatures Act § 104(b)(3)(A).
46 146 Cong. Rec. S5230 (daily ed. June 14, 2000) (statement of Sens. Hollings, Wyden, and Sarbanes).
47 See e.g., In the Matter of Del Mar Financial Services, Inc., et al., Exchange Act Release No. 42421 (Feb. 14, 2000); In the Matter of A.S. Goldmen & Co., Inc., et al., Exchange Act Release No. 41601 (July 7, 1999).
48 Adopting Release, 62 FR at 6470.
50 146 Cong. Rec. S5221 (daily ed. June 15, 2000) (statement of Sen. Leahy).
51 See 146 Cong. Rec. S5230 (daily ed. June 15, 2000) (statement of Sens. Hollings, Wyden and Sarbranes); 146 Cong. Rec. H4358 (daily ed. June 14, 2000) (statement of Rep. Dingell).

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