BROKER-DEALERS—WORM spurned: SEC modernizes electronic recordkeeping requirements for broker-dealers - 13 October 2022
Broker-dealers and SBS entities are no longer bound by late-90s technology when preserving electronic records.
The SEC unanimously adopted amendments to modernize its broker-dealer electronic recordkeeping requirements. The amendments to Exchange Act rules 17a-4 and 18a-6 modify requirements regarding the maintenance and preservation of electronic records, the use of third-party recordkeeping services to hold records, and the prompt production of records. The use of electronic recordkeeping by broker-dealers, security-based swap dealers, and major security-based swap participants has been allowed since 1997, and the rules were based on the storage methods of the time. The new amendments modernize the rules, apply the same requirements to broker-dealers and nonbank SBSDs and MSBSPs, and make the rules more adaptable to technological changes (Electronic Recordkeeping Requirements for Broker-Dealers, Security-Based Swap Dealers, and Major Security-Based Swap Participants, Release No. 34-96034, October 12, 2022).
WORM's germ. Rules 17a-f and 18a-6 set out the electronic recordkeeping and production requirements for broker-dealers and security-based swap dealers (SBSDs), and major security-based swap participants ("MSBSPs"), respectively. Adopted in 1997, the rules were rooted in the technology of that time and required that records be preserved exclusively in a non-rewriteable, non-erasable format known as write once, read many (WORM). While the rules were intended to be technology neutral, WORM essentially meant optical disks such as CD-ROMs or DVDs. A later interpretation allowed the use of rewritable hardware storage media that used integrated codes to prevent records from being altered, over-written, or erased during the required retention period.
The Commission proposed to amend the requirements in November 2021. Specifically, the Commission proposed to amend the electronic record maintenance and preservation requirements of Rules 17a-4(f) and 18a-6(e) and the prompt production of records requirements of Rules 17a-4(j) and 18a-6(g). Commenters generally supported replacing the term "electronic storage system" with "electronic recordkeeping system" as being generic and flexible enough to last through foreseeable technological changes.
Amendments. The amendments to Rules 17a-4 and 18a-6 require a broker-dealer or nonbank SBSD or MSBSP using an electronic recordkeeping system to ensure that the system meets either the audit-trail requirement or the WORM requirement. Prior to these changes, Rule 18a-6 did not require an SBS entity to use an electronic recordkeeping system meeting either of these requirements. The audit trail requirement requires the use of an electronic recordkeeping system that maintains and preserves electronic records in a manner that permits the recreation of an original record if it is modified or deleted. The audit trail option, the Commission says, addresses concerns about the WORM requirement while preserving electronic records in a manner that protects the authenticity and reliability of the original records.
The amendments add to an existing provision in Rule 17a-4 requiring that firms engage a third party with the ability to provide the records to regulators if the firm fails to do so. The amendments make these undertakings more technology neutral and alternatively allow an executive officer to be designated to execute these undertakings. Amendments to Rule 18a-6 add the third-party undertakings provision and alternative executive officer undertakings provision and require those undertakings to be filed with the Commission. The amendments also provide for alternative undertakings where records are maintained on servers or other storage devices operated by third parties, e.g., cloud service providers.
Next, broker-dealers, SBSDs, and MSBSPs are required to produce electronic records in a reasonably usable electronic format to allow securities regulators to search and sort information on the records. This means that records will be produced in a format compatible with commonly used systems for accessing and reading electronic records. Finally, a requirement that a broker-dealer notify its designated examining authority before employing an electronic recordkeeping system has been eliminated.
The amendments will be effective 60 days after publication in the Federal Register. Broker-dealers must comply with the new requirements six months after publication, and SBSDs and MSBSPs must comply 12 months after publication.
Commissioners react. "I am pleased to support these rule amendments because they will bring the Commission's electronic recordkeeping requirements for intermediaries such as broker-dealers and security-based swap dealers in line with technological innovation," said SEC Chair Gary Gensler. "Since the 1930s, recordkeeping obligations have been vital to maintain market integrity and the SEC's work as the cop on the beat. Today's rule amendments will facilitate the SEC’s ability to examine and inspect records consistent with modern technology. This will enhance the Commission's ability to preserve market integrity and protect investors." The other commissioners echoed Gensler's support an alternative to WORM, although some, such as Commissioner Peirce, wondered if even this rule can include all future technologies. "We could be far more confident in the staying power of our rule if we were instead considering a principles-based approach that specified the objective we expected firms to achieve and allowed them to find the best technology available to them to reach this goal," Peirce said.
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