[Federal Register Volume 66, Number 88 (Monday, May 7, 2001)]
[Rules and Regulations]
[Pages 22916-22921]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-11333]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 241
[Release No. 34-44238]
Commission Guidance to Broker-Dealers on the Use of Electronic
Storage Media Under the Electronic Signatures in Global and National
Commerce Act of 2000 With Respect to Rule 17a-4(f)
AGENCY: Securities and Exchange Commission.
ACTION: Interpretation.
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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 May 7, 2001.
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.
I. Introduction
The Electronic Signatures in Global and National Commerce Act of
2000 (the ``Electronic Signatures Act'') \1\ seeks to promote
electronic commerce by providing greater legal certainty to
transactions effected by electronic means. To this end, the Electronic
Signatures Act provides that the legal validity of a signature or
contract cannot be denied solely because it is in electronic form.\2\
It also encourages electronic record storage by providing that any
statute, regulation, or other rule of law that requires the retention
of contracts or other records relating to transactions in or affecting
interstate or foreign commerce may, with certain exceptions, be
complied with by storing the documents electronically.\3\ However, the
Electronic Signatures Act requires that the electronically stored
documents must accurately reflect the information in the contracts or
transactional records and be accessible to all persons entitled to
review them under statute, regulation, or rule of law in a form that is
capable of being accurately reproduced for later reference.\4\ The
Electronic Signatures Act does not define how these requirements are to
be met. Instead, it preserves the ability of regulatory agencies to
interpret them with respect to statutes under which such agencies have
rulemaking authority.\5\
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\1\ Pub. L. 106-229, 114 Stat. 464 (2000).
\2\ Electronic Signatures Act Section 101(a).
\3\ Electronic Signatures Act Section 101(d)(1).
\4\ Id.
\5\ Electronic Signatures Act Section 104(b).
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On March 1, 2001, the Electronic Signatures Act became effective
with respect to any existing state or federal regulatory requirement
that a contract or transactional record be retained.\6\ This effective
date is delayed, however, if an agency has announced, proposed or
initiated, but not completed, a rulemaking proceeding under the
authority preserved in the Electronic Signatures Act.\7\ On February
28, 2001, the Commission announced that it would act shortly to provide
interpretive guidance and, where appropriate, propose or adopt rules
consistent with the Electronic Signatures Act, thereby delaying the
effective date with respect to Commission recordkeeping rules to June
1, 2001.\8\
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\6\ Electronic Signatures Act Section 107(b)(1).
\7\ Electronic Signatures Act Section 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>.
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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.
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\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'').
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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.
II. Background
A. Broker-Dealer Books and Records Rules
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
[[Page 22917]]
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.
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\11\ 15 U.S.C. 78q(a)(1).
\12\ Exchange Act Release No. 2304 (Nov. 13, 1939), 4 FR 4578
(Jan. 2, 1940).
\13\ 17 CFR 240.17a-3.
\14\ 17 CFR 240.17a-4.
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Originally, Rule 17a-4 had a paper-only requirement for the initial
retention of records; now, the rule allows broker-dealers to choose
between storing records in paper form, on microfilm or microfiche
(``micrographic media'') or using electronic storage media. This
progression from paper to electronic media is indicative of how the
Commission encourages the use of technological innovation when both
broker-dealers and investors will benefit.\15\
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\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.
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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.
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\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).
\18\ Id.
\19\ Id.
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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.
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\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).
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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.
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\22\ Letter from Michael A. Macchiaroli, Associate Director,
Division, to Michael D. Udoff, Chairman, Ad Hoc Record Retention
Committee, SIA (June 18, 1993).
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In 1997, the Commission, in many respects, codified the Division's
no-action letter by amending paragraph (f) of Rule 17a-4 to allow
broker-dealers to store records electronically.\23\ However, one
significant difference was that the final rule did not limit broker-
dealers to using optical disk. Instead, it allowed them to employ any
electronic storage medium, subject to certain requirements. For the
most part, these requirements are the same safeguards proposed by the
SIA in its 1992 no-action request and later required by the Division in
its 1993 no-action letter. It is these requirements of Rule 17a-4 that
we now find meet, and are consistent with, the Electronic Signatures
Act.\24\
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\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).''
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[[Page 22918]]
B. The Electronic Storage Requirements of the Electronic Signatures Act
Section 101(d)(1) of the Electronic Signatures Act permits persons
who are legally required to retain contracts or records relating to
transactions in or affecting interstate or foreign commerce to do so
using electronic means. However, Section 101(d)(1) also requires
persons who opt to store such records in electronic form to proceed in
a manner that ensures the records are accurate, accessible, and capable
of accurate reproduction for later reference. As Section 101(d)(1)
reads in full,
If a statute, regulation, or other rule of law requires that a
contract or other record relating to a transaction in or affecting
interstate or foreign commerce be retained, that requirement is met
by retaining an electronic record of the information in the contract
or other record that--
(A) accurately reflects the information set forth in the
contract or other record; and
(B) remains accessible to all persons who are entitled to access
by statute, regulation, or rule of law, for the period required by
such statute, regulation, or rule of law, in a form that is capable
of being accurately reproduced for later reference, whether by
transmission, printing, or otherwise.\25\
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\25\ Electronic Signatures Act Sec. 101(d)(1).
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.
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\26\ Electronic Signatures Act Sec. 104(b).
\27\ Electronic Signatures Act Sec. 104(b)(2)(A).
\28\ Electronic Signatures Act Sec. 104(b)(2)(B).
\29\ Electronic Signatures Act Sec. 104(b)(2)(C).
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III. Analysis
The Electronic Signatures Act becomes effective on June 1, 2001
with respect to Rule 17a-4.\30\ To the extent Rule 17a-4 requires the
retention of the types of contracts and transactional records
identified in the Electronic Signatures Act, broker-dealers will be
able to retain them electronically under Section 101(d)(1), provided
the electronic records are accurate, accessible, and capable of being
accurately reproduced for later reference. Under paragraph (f) of Rule
17a-4, broker-dealers are already permitted to retain all required
records--not just these contracts and transactional records--using
electronic means, subject to the requirements set forth in that
paragraph. Pursuant to the Commission's interpretive authority
preserved by the Electronic Signatures Act, we find that the electronic
storage requirements of Rule 17a-4(f) meet, and are consistent with,
the accuracy, accessibility, and accurate reproduction requirements of
Section 101(d)(1) of the Electronic Signatures Act. Therefore, broker-
dealers must continue to comply with the electronic storage
requirements of Rule 17a-4(f) after June 1, 2001.\31\
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\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.
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A. The Electronic Storage Requirements of Rule 17a-4(f) Are Consistent
With Section 101(d) of the Electronic Signatures Act
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.
Second, the Electronic Signatures Act and the electronic storage
requirements of Rule 17a-4(f) were each designed to allow affected
parties to take advantage of the increased productivity and cost
savings arising from the use of electronic storage systems. To quote
Representative Sessions, ``the underlying legislation will allow all
Americans to benefit from the efficiencies resulting from advances in
technology.'' \32\ Similarly, the Commission, when adopting its
electronic storage rule, stated that the amendments were ``a
recognition of technological developments that will provide economic as
well as time-saving advantages for broker-dealers by expanding the
scope of recordkeeping options.* * *'' \33\
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\32\ 146 Cong. Rec. H4347 (daily ed. June 14, 2000) (statement
of Rep. Sessions).
\33\ Adopting Release, 62 FR at 6469.
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Third, there is explicit support in the legislative history for our
finding that Rule 17a-4(f) is consistent with the Electronic Signatures
Act. As noted by Representative Dingell, ``[t]he standards set forth in
the SEC's existing electronic recordkeeping rule, Rule 17a-4(f), such
as the requirement that an electronic recordkeeping system preserve
records in a non-rewriteable and non-erasable manner, are essential to
the SEC's investor protection mission and are consistent with the
provisions of the conference report [on the Electronic Signatures
Act].'' \34\
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\34\ 146 Cong. Rec. H4358 (daily ed. June 14, 2000) (statement
of Rep. Dingell) (emphasis added).
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B. The Electronic Storage Requirements of Rule 17a-4(f) Do Not Add
Requirements to Section 101(d) of 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
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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.
C. The Commission Makes the Findings Required by Section 104(b)(2)(C)
of the Electronic Signatures Act
In exercising its authority to interpret its statutes, as preserved
in the Electronic Signatures Act, the Commission must make four
findings: (1) That there is substantial justification for the
interpretation; (2) that the methods selected to carry out that purpose
are substantially equivalent to the requirements imposed on records
that are not electronic; (3) that the methods selected to carry out
that purpose will not impose unreasonable costs on the acceptance and
use of electronic records; and (4) that 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.\35\
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\35\ Electronic Signatures Act Sec. 104(b)(2)(C).
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1. There Is Substantial Justification for the Commission's
Interpretation of Rule 17a-4(f)
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.
Commission enforcement actions against unscrupulous broker-dealers
that improperly altered or destroyed records demonstrate the need for
measures aimed at maintaining the integrity of broker-dealer records.
These cases have included situations in which broker-dealer employees
have changed or destroyed order tickets and other transactional records
in an effort to shift firm losses to their customers or to conceal
fraudulent activities.\36\
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\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).
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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.
2. The Electronic Storage Requirements of Rule 17a-4(f) Are
Substantially Equivalent to the Requirements for Records That Are Not
Electronic
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.
The examination process, which is fundamental to the regulation of
broker-dealers, depends on the ability of examiners to quickly obtain
records that are relevant to a particular examination and that reflect
the information as originally entered into the record. This need is
complicated by the record-intensive nature of the securities industry.
Rule 17a-4 seeks to address the tension between the need for quick
production of specific records and the volume of records generated on a
daily basis, by requiring that more current records be retained in an
easily accessible place. It also requires that every broker-dealer
``shall furnish promptly * * * legible, true and complete copies of
those records'' requested by representatives of the Commission.\37\
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\37\ 17 CFR 240.17a-4(j).
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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
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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.
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\38\ 17 CFR 240.17a-4(f)(3)(i) and (ii).
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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.
3. The Electronic Storage Requirements of Rule 17a-4(f) Do Not Impose
Unreasonable Costs on the Acceptance and Use of Electronic Records
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.
4. The Electronic Storage Requirements of Rule 17a-4(f) Do Not Require,
or Accord Greater Legal Status or Effect to, the Implementation or
Application of a Specific Technology or Technical Specification
The Commission first proposed amending Rule 17a-4 to allow
electronic storage in 1993.\39\ The proposed amendments would have
limited broker-dealers to using optical disk. However, the Commission
ultimately adopted a rule that allows the use of any electronic storage
medium that meets the general requirements of the rule.\40\ Moreover,
in discussing the WORM provision of the rule, the Commission made clear
that this did not mean only one type of storage methodology. As the
Commission stated in the release,
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\39\ Exchange Act Release No. 32609 (July 9, 1993), 58 FR 38092
(July 15, 1993).
\40\ Adopting Release, 62 FR 6469.
In the Proposing Release, the Commission did not intend the
definition of optical storage technology to include only ablative
methodology of storage. The Commission recognizes that other methods
of electronic storage technology exist, including optical tape and
CD-ROM, which is available in a WORM, non-rewriteable version. The
Commission is adopting a rule today, which, instead of specifying
the type of storage technology that may be used, sets forth
standards that the electronic storage media must satisfy to be
considered an acceptable method of storage under Rule 17a-4.
Specifically, because optical tape, CD-ROM, and certain other
methods of electronic storage are available in WORM and can provide
the same safeguards against data manipulation and erasure that
optical disk provides, the final rule clarifies that broker-dealers
may employ any electronic storage media that meets the conditions
set forth in the final rule.\41\
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\41\ Adopting Release, 62 FR at 6470.
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.
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\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).
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D. The Electronic Storage Requirements of Rule 17a-4(f) Would Be
Permissible Performance Standards Under Section 104(b)(3) of the
Electronic Signatures Act
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
[[Page 22921]]
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.
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\43\ Electronic Signatures Act Section 104(b)(3)(A).
\44\ Id.
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1. The Electronic Storage Requirements of Rule 17a-4(f) Serve an
Important Governmental Interest
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.\45\ This
grant of authority recognizes the importance of broker-dealer
recordkeeping to the Commission's regulatory function and investor
protection objective. Rule 17a-4, adopted by the Commission pursuant to
this authority, sets forth the requirements for keeping and furnishing
broker-dealer records. In so doing, the rule serves the important
governmental interest of assisting adequate supervision of broker-
dealers by the Commission and the SROs. During the debate on the
Electronic Signatures Act, the importance of accurate recordkeeping in
regulated industries was noted. To quote a statement by Senators
Hollings, Wyden and Sarbanes, ``bank and other financial regulators
need to require that records be retained in order that their examiners
can insure the safety and soundness of the institutions and compliance
with all relevant regulatory requirements.'' \46\
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\45\ 15 U.S.C. 78q(a)(1).
\46\ 146 Cong. Rec. S5230 (daily ed. June 14, 2000) (statement
of Sens. Hollings, Wyden, and Sarbanes).
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Investor protection depends on the examination process, which, in
turn, relies on the records that broker-dealers are required to make
and maintain. The electronic storage requirements of Rule 17a-4(f) are
designed to ensure that broker-dealers will meet their obligation under
Section 17(a)(1) and Rule 17a-4 to promptly furnish legible, true and
complete copies of such records as are requested by the Commission or
its representatives. This is crucial to the Commission's mandate to
protect investors. Accordingly, the Commission's regulatory function is
undermined to the extent that these records are inaccurate, retained in
a non-accessible manner, or capable of alteration. The Commission's
enforcement record against unscrupulous broker-dealers that have
changed or destroyed records demonstrates how such conduct can harm
investors and the public interest.\47\
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\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).
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2. The Electronic Storage Requirements of Rule 17a-4(f) Are
Substantially Related to the Important Governmental Interest
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.
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\48\ Adopting Release, 62 FR at 6470.
\49\ Id.
\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 Sarbanes); 146 Cong. Rec.
H4358 (daily ed. June 14, 2000) (statement of Rep. Dingell).
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IV. Conclusion
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.
List of Subjects in 17 CFR Part 241
Securities.
Amendments to the Code of Federal Regulations
For the reasons set forth in the preamble, the Commission is
amending title 17, chapter II of the Code of Federal Regulations as set
forth below:
PART 241--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES
EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER
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.
Dated: May 1, 2001.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-11333 Filed 5-4-01; 8:45 am]
BILLING CODE 8010-01-U