SEC Proposes Amendments to Rule 17a-4 Electronic Recordkeeping Requirement

The Securities and Exchange Commission, on November 18, 2021, proposed amendments to the “write once, read many” (WORM) format requirement for electronic recordkeeping applicable to broker-dealers, security-based swap dealers and major security-based swap participants (Proposed Amendments). The Proposed Amendments also include corresponding changes to the requirements for providing “true, complete, and current” records to the SEC.¹ The Proposed Amendments would revise paragraphs (f) and (j) of Rule 17a-4 (Rule) under the Securities Exchange Act of 1934, as well as the corollary provisions applicable to security-based swap dealers, and major security-based swap participants.² According to the SEC’s release setting forth the Proposed Amendments (Release), the amendments are intended to: modernize the electronic preservation and production requirements; and harmonize electronic recordkeeping systems into a single system for business and regulatory purposes.

Comments on the Proposed Amendments must be received by January 3, 2022.

Background

The current electronic recordkeeping requirements for broker-dealers, codified under paragraph (f) of the Rule, have been in place since 1997. The Rule currently requires that records be maintained and reproduced on “micrographic media” or “by means of ‘electronic storage media.’”³ As stated in the Release, these requirements were intended to be “technology neutral.” At the time the Rule was adopted, the predominant electronic storage methods included optical disks (e.g., CD-ROMS and DVDs). As the industry well knows, however, these media have become technologically obsolete.

Further, the Rule currently requires electronic preservation to be in a WORM format, which is meant to prevent the alteration of records. To comply with the WORM requirement, some broker-dealers have used a specific WORM-compliant system, which, according to the Release, “prevents the overwriting, erasing or otherwise altering of a record … through the use of integrated hardware and software codes.” However, the electronic recordkeeping systems used by broker-dealers for trading, risk management and other business purposes are dynamic and updated constantly (i.e., with each new transaction or position). In addition to specifying that books and records be retained in WORM format, the Rule currently requires a broker-dealer to engage a third party that is provided with access to electronic records and undertakes to be responsible for providing the SEC with access to such books and records upon request.

In November 2017, the Securities Industry and Financial Markets Association, Financial Services Roundtable, Futures Industry Association, International Swaps and Derivatives Association and Financial Services Institute submitted a petition for rulemaking (Petition) to the SEC requesting the elimination of various outdated requirements of the Rule. Specifically, the Petition requested that the SEC eliminate the following requirements: the WORM format for maintaining electronic records; notification to a designated examining authority; third-party access of electronic records; and maintenance of an audit system for accountability purposes.⁴ As discussed below, these requirements have been addressed by the SEC in the Proposed Amendments and were either eliminated or modified.

Given the major advances in technology since 1997, the SEC has proposed several additional amendments to modernize the Rule.

Key Proposed Revisions to Rule 17a-4

Throughout the Rule, the SEC proposes to change the phrase “electronic storage media” to “electronic recordkeeping system.” According to the Release, the SEC believes that the current term refers to hardware storage, while the proposed phrase would more accurately encompass both hardware and software for electronic storage. “Electronic recordkeeping system” would be defined as “a system that preserves records in a digital format and that requires a computer to access the records.” The SEC also proposes to make the same changes under Exchange Act Rule 18a-6 for security-based swap dealers and major security-based swap participants.⁵ In connection with these proposed changes to the Rule, the SEC also proposes to eliminate the notice and representation that a broker-dealer must provide to its designated examining authority (or DEA) in any instance where such broker-dealer intended to employ an electronic storage media other than optical disk technology.⁶

The SEC noted in the Release that, for business purposes, many broker-dealers use electronic recordkeeping systems that are dynamic and constantly updated, rather than WORM-compliant systems.

The Proposed Amendments would revise the Rule’s current requirement to maintain records by means of micrographic media, to permit broker-dealers to maintain records using a compliant electronic recordkeeping system. As proposed to be revised, paragraph (f) of the Rule would require that a broker-dealer using an electronic recordkeeping system preserve its records in a manner “that permits original records to be re-created if altered, over-written, or erased, or that prevents original records from being altered, over-written or erased.” According to the SEC, this requirement is intended to address the issue that certain broker-dealers have needed to engage multiple storage systems to be WORM-compliant.

The requirements for a compliant electronic recordkeeping system as proposed by the SEC include:

• An “audit-trail” that would maintain a “complete time-stamped audit trail” documenting specific information (e.g., individuals modifying the record at any given time, time and date stamp for all actions taken in regard to the record);
  
  
• A capacity to automatically verify the completeness and accuracy of original records stored to the electronic recordkeeping system; and
  
  
• A capacity to readily download and transfer copies of a record and its audit trail in both “a human readable format and in a reasonably usable electronic format.”⁷

The SEC also proposes to eliminate the current third-party access and undertakings requirement. Instead, the SEC would require a broker-dealer to engage a senior officer, with “independent access to and the ability to provide the records,” to furnish such records to the SEC upon request. The Release indicates that the SEC believes this Proposed Amendment would “address cybersecurity and trade secret concerns” that may arise when engaging a third party in this capacity. It is important to note that the SEC expects a broker-dealer to furnish its records to the SEC upon request, and the senior officer would be required to fulfill these obligations only in the event the broker-dealer was non-compliant.

As a result of the Proposed Amendments to paragraph (f) of the Rule, the SEC also proposes to revise paragraph (j) to require that records, together with any related audit trail, be furnished to the SEC “in a reasonably usable electronic format.”⁸

Conclusion

The Proposed Amendments are a long-awaited step forward in modernizing broker-dealers’ recordkeeping obligations to reflect technological advances. Nevertheless, they leave unanswered a number of interpretive questions relating to electronic communications and other record retention issues.

Footnotes

1) Electronic Recordkeeping Requirements for Broker-Dealers, Security-Based Swap Dealers, and Major Security-Based Swap Participants (Release) (Nov. 18, 2021), 86 Fed. Reg 68300.

2) Specifically, the SEC also is proposing corresponding amendments to 1934 Act Rule 18a-6(e), which codifies the electronic recordkeeping requirements for securities-based swap dealers and major security-based swap dealers that are not also broker-dealers. Release, supra note 1.

3) “Micrographic media” refers to “microfilm or microfiche, or any similar medium” and “electronic storage media” refers to a “digital storage medium or system.”

4) Petition 4-713 (Nov. 14, 2017).

5) Note that Rule 18a-6(e) uses the term “electronic storage system” rather than “electronic storage media.”

6) As discussed below, the Proposed Rule does not completely eliminate the third-party undertaking requirement, rather it substitutes a senior officer of the broker-dealer firm for the third party.

7) Release, supra note 1.

8) Id.