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93-47 SEC Permits Use of Optical Storage Technology for Records Retention

SUGGESTED ROUTING

Senior Management
Internal Audit
Legal & Compliance
Operations
Systems

Executive Summary

On May 18, 1993, the Securities and Exchange Commission (SEC) issued a no-action letter that permits broker/dealers to use optical storage technology(OST) to comply with the records retention requirements of SEC Rules 17a-3 and 17a-4. The letter, which was issued by the SEC Division of Market Regulation, establishes certain conditions that broker/dealers must meet to use this technology.

Background

Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 contain specific requirements for broker/dealers to follow in making and preserving books, records, and other documents relating to their business activities. Until 1970, paper was the only medium used to comply with these requirements. Over time, the SEC granted permission for broker/dealers to use microfilm and microfiche for records retention. In May 1993, the Securities Industry Association (SIA) Ad Hoc Record Retention Committee petitioned the SEC to allow the use of optical storage technology to maintain records.

In its letter, the SEC concurs with using OST if "broker/dealers immediately produce or reproduce records required under Rules 17a-3 and 17a-4, other than paper records made and kept current pursuant to paragraphs (a)(6) and (a)(7) of Rule 17a-3, on an optical disk, and maintain and preserve such records for the required time in that form," provided they meet certain specified conditions. Paragraphs (a)(6) and (a)(7) refer to order and trade tickets that are not eligible for optical storage.

Conditions for Use

Broker/dealers that use OST for recordkeeping must comply with the following conditions.

1. The broker/dealer must notify its designated examining authority before employing OST for record-retention purposes.
2. At all times, the broker/dealer must have facilities for immediate, easily readable projection of optical disks and for producing easily readable facsimile enlargements of such images so that the SEC and appropriate SROs may examine the broker/dealer records.
3. The broker/dealer must arrange the records and indexes and file the optical disks in such a manner as to permit the immediate location of any particular record.
4. The broker/dealer must be able to immediately provide at all times any facsimile enlargement that the SEC, through its examiners or other representatives, may request.
5. The broker/dealer must store separately from the original, in an off-site location, a duplicate copy of each optical disk used to store the required records, and stores such optical disk for the period required for the information preserved on the optical disk.
6. The broker/dealer must employ optical storage that:
(a) preserves records exclusively in a non-rewriteable, non-erasable format;
(b) verifies automatically the quality and accuracy of the optical storage recording process;
(c) duplicates in a separate optical disk all information originally preserved and maintained by means of OST;
(d) serializes original and duplicate optical disks containing records, and time-dates permanently the information placed on such optical disks; and
(e) has the capacity to download indexes and records preserved on optical disks into paper, microfilm, or microfiche.
7. The broker/dealer must organize and index accurately all information contained in every original and duplicate optical disk to ensure prompt access to the records.
(a) At all times, a broker/dealer must be able to have such indexes available for examination by the staffs of the SEC and the self-regulatory organizations (SROs) to which the broker/dealer belongs.
(b) Each index must be duplicated and the duplicate copies must be stored in an off-site location, separately from the original copy of each index.
(c) Original and duplicate indexes must be preserved for the time required for the indexed records.
8. The broker/dealer must have in place an audit system providing for accountability regarding all access to records maintained and preserved using OST and any changes made to every original and duplicate optical disk.
(a) At all times, a broker/dealer must be able to have the results of such audit system available for examination by the staffs of the SEC and the SROs to which the broker/dealer belongs.
(b) The results of such audit system must be preserved for the time required for the audited records.
9. The broker/dealer must maintain, keep current, and surrender promptly on request by the staffs of the SEC or the SROs to which the broker/dealer belongs all information needed to download records and indexes stored on optical disks; or place in escrow and keep current a copy of the physical and logical file format of the optical disks, the field format of all different information types written on the optical disks and the source code, together with the appropriate documentation and all information needed to download records and indexes.
10. For every broker/dealer using OST for record preservation purposes, at least one third-party who can download information from the broker/dealer's optical unit to another acceptable medium (the undersigned) shall file with the SEC or its designee the following written undertakings:
The undersigned hereby undertakes to promptly furnish to the U. S. Securities and Exchange Commission (Commission), its designees or representatives, upon reasonable request, such information as is deemed necessary by the Commission's staff to download information kept on the broker/dealer's optical storage system to another medium acceptable to the Commission's staff.

Furthermore, the undersigned hereby undertakes to take reasonable steps to provide access to information contained on the broker/dealer's optical storage system, including, as appropriate, arrangements for the downloading of any record, required to be maintained and preserved by the broker/dealer pursuant to Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 in a format acceptable to the Commission's staff. Such arrangements will provide specifically that in the event of a failure on the part of the broker/dealer to down load the record into a readable format, upon being provided with the appropriate optical disks, the undersigned will undertake to do so, as the Commission's staff may request.

* * * * *

The SEC no-action letter that follows this Notice contains details regarding how the technology works and some background information concerning its advantages. Members planning to use optical storage technology should review the letter in its entirety. Questions concerning this Notice may be directed to Derick Black, Surveillance Specialist, Financial Responsibility, Compliance Department, at (202) 728-8225.

* * * * *

June 18, 1993

Michael D. Udoff, Chairman
Ad Hoc Record Retention Committee
Securities Industry Association, Inc.
120 Broadway
New York, NY 10271
Re: Optical Storage Technology

Dear Mr. Udoff:

Thank you for your letter, dated May 19, 1992, on behalf of the Securities Industry Association's ("SIA") Ad Hoc Record Retention Committee ("Committee"), regarding the form by which broker-dealers may maintain records, required to be retained pursuant to Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 ("Act").1

I. BACKGROUND
A. Preservation requirements under Rules 17a-3 and 17a-4

Rules 17a-3 and 17a-4 specify minimum requirements with respect to the business records which must be made by broker-dealers as well as the periods during which such records and other documents relating to the broker-dealer's business must be preserved. For the most part, records preserved pursuant to these Rules must be kept for up to six years, the first two years in an easily accessible place.2 Some records, however, must be preserved for three years,3 and records concerning the legal existence of the broker-dealer (e.g., partnership articles, minute books, stock certificate books) must be preserved during the life of the broker-dealer and its successors.4

Until 1970, paper was the sole medium for the preservation of the records required under Rules 17a-3 and 17a-4. In 1970, Rule 17a-4 was amended to permit records to be immediately produced on microfilm for record-keeping purposes.5 This amendment allowed for the use of microfilm for record preservation purposes provided that the conditions set forth in paragraph (f) of Rule 17a-4 were met.6 In 1979, the staff of the Securities and Exchange Commission ("Commission") interpreted Rule 17a-4 to include microfiche as well as microfilm for record-keeping purposes, provided that the requirements of Rule 17a-4(f) were satisfied.7

Your letter, dated May 19, 1992, proposes to further expand the manner in which records required under Rules 17a-3 and 17a-4 may be preserved. In particular, the Committee requests that the Division of Market Regulation ("Division") not recommend that the Commission take enforcement action under Rules 17a-3 and 17a-4 if broker-dealers maintain the required records only on optical disk storage.
B. Optical storage technology

Optical storage technology allows for digital data recording in a hardware controlled, non-rewriteable format, such as write once, read many ("WORM"), which provides a non-alterable, permanent record storage medium. Non-rewriteable optical storage medium records digital information by employing a laser heat source to burn a pattern on a metallic film on a disk surface that can hold billions of bytes of data ("optical disk").8 Once a laser permanently marks the optical disk to store information, that information can not be modified or removed from the optical disk without detection. This disk is removable from the hardware necessary for the optical storage function.

When using optical disk storage in the non-rewriteable format, any record, be it computer generated (such as a computer report) or electronically digitized (such as from paper or micrographics), can be permanently recorded for long term computer based management and access.
II. PROPOSAL

The Committee requests that the Division not recommend that the Commission take enforcement action under Rules 17a-3 and 17a-4 if a broker-dealer preserves its records by employing optical storage technology. According to the SIA, optical storage technology will provide economic as well as timesaving advantages for broker-dealers. For example, the SIA estimates that savings for space, equipment and material expenses, resulting from a change to optical disk from microfilm, range from $250,000 a year for a medium-sized firm to more than $1.6 million a year for a large firm.

The SIA asserts that optical storage technology offers speedier and higher quality access to records thus preserved than the current access to records preserved in microfilm, microfiche or physical format. Accordingly, the SIA asserts that the use of optical storage technology will enable broker-dealers to improve customer service. For example, according to the SIA, customers who lose account statements can be provided readily with replacement copies of equivalent quality to the original.9

Furthermore, the SIA asserts that optical disk storage of a firm's records would increase productivity and security. With optical storage technology an individual would not require physical access to a particular record, because access to an electronic copy would be equally available to authorized persons through a computer terminal. Access to records, however, could be restricted within a firm or individual department. Individuals could have access based solely on their employment responsibilities. Accordingly, the risk that records would be lost, misfiled or damaged through use would be reduced.

According to the SIA, optical storage technology would enhance the process of providing information more readily to the Commission. The SIA states that these benefits also would accrue to the benefit of the Commission in any record analysis done, because the Commission's staff would have the same ready, rapid access to the stored information, thus increasing the efficiency of the review process.

The SIA recognizes, however, that industry standards for the development of optical storage technology are currently being set, and that there are audit and examination concerns. Because the technology is new, optical storage systems are not always compatible (i.e., information stored on an optical disk of one manufacturer may not be read by the technology developed by a second manufacturer). As a result of this lack of industry standards, the Commission or a self-regulatory organization ("SRO") inspecting a broker-dealer may encounter difficulty examining the information on an optical disk, because the technology owned by the inspecting SRO may not be compatible with the optical storage technology used by the broker-dealer to store the information. Accordingly, the Committee recommends that, upon compliance with conditions similar to those set forth below, broker-dealers be allowed to preserve records by employing optical storage technology.
III. CONCLUSION

Based on the above facts, and with regard to the issues set forth in this letter, the Division will not recommend that the Commission take enforcement action pursuant to Section 17(a)(1) of the Act10 and Rules 17a-3 and 17a-411 thereunder if, under the circumstances described below, broker-dealers immediately produce or reproduce records required under Rules 17a-3 and 17a-4, other than paper records made and kept current pursuant to paragraphs (a)(6) and (a)(7) of Rule 17a-3, on an optical disk, and maintain and preserve such records for the required time in that form.
1. The broker-dealer must notify its designated examining authority prior to employing optical storage technology for record-retention purposes.
2. At all times, the broker-dealer must have available for examination of its records by the staffs of the Commission and the SROs of which it is a member, facilities for immediate, easily readable projection of optical disks and for producing easily readable facsimile enlargements of such images.
3. The broker-dealer must arrange the records and indexes, and file the optical disks in such a manner as to permit the immediate location of any particular record.
4. The broker-dealer must be ready at all times to provide, and immediately provides, any facsimile enlargement which the Commission by its examiners or other representatives may request.
5. The broker-dealer must store separately from the original, in an off-site location, a duplicate copy of each optical disk used to store the required records, and stores such optical disk for the period required for the information preserved in the optical disk.
6. The broker-dealer must employ optical storage that:
(a) preserves records exclusively in a non-rewriteable, non-erasable format;
(b) verifies automatically the quality and accuracy of the optical storage recording process;
(c) duplicates in a separate optical disk all information originally preserved and maintained by means of optical storage technology;
(d) serializes original and duplicate optical disks containing records, and time-dates permanently the information placed on such optical disks, and
(e) has the capacity to download indexes and records preserved on optical disks into paper, microfilm or microfiche.
7. The broker-dealer must organize and index accurately all information contained in every original and duplicate optical disk to ensure prompt access to the records.
(a) At all times, a broker-dealer must be able to have such indexes available for examination by the staffs of the Commission and the SROs of which the broker-dealer is a member.
(b) Each index must be duplicated and the duplicate copies must be stored in an off-site location, separately from the original copy of each index.
(c) Original and duplicate indexes must be preserved for the time required for the indexed records.
8. The broker-dealer must have in place an audit system providing for accountability regarding all access to records maintained and preserved using optical storage technology and any changes made to every original and duplicate optical disk.
(a) At all times, a broker-dealer must be able to have the results of such audit system available for examination by the staffs of the Commission and the SROs of which the broker-dealer is a member.
(b) The results of such audit system must be preserved for the time required for the audited records.
9. The broker-dealer must maintain, keep current and surrender promptly upon request by the staffs of the Commission or the SROs of which the broker-dealer is a member all information necessary to download records and indexes stored on optical disks; or place in escrow and keep current a copy of the physical and logical file format of the optical disks, the field format of all different information types written on the optical disks and the source code, together with the appropriate documentation and all information necessary to download records and indexes.
10. For every broker-dealer using optical storage technology for record preservation purposes, at least one third party who has the ability to download information from the broker-dealer's optical unit to another acceptable medium ("the undersigned"), shall file with the Commission or its designee the following written undertakings:
The undersigned hereby undertakes to promptly furnish to the U.S. Securities and Exchange Commission ("Commission"), its designees or representatives, upon reasonable request, such information as is deemed necessary by the Commission's staff to download information kept on the broker-dealer's optical storage system to another medium acceptable to the Commission's staff.

Furthermore, the undersigned hereby undertakes to take reasonable steps to provide access to information contained on the broker-dealer's optical storage system, including, as appropriate, arrangements for the downloading of any record, required to be maintained and preserved by the broker-dealer pursuant to Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 in a format acceptable to the Commission's staff. Such arrangements will provide specifically that in the event of a failure on the part of the broker-dealer to download the record into a readable format, upon being provided with the appropriate optical disks, the undersigned will undertake to do so, as the Commission's staff may request.
This is a staff position concerning enforcement action and it does not represent any legal conclusions. This position is based solely on the foregoing description and factual variations might require a different response. This position may be withdrawn or modified if the staff determines that such action is necessary in the public interest, for the protection of investors, or other wise, in furtherance of the purposes of the Federal securities laws.

If you have any questions regarding these matters, please do not hesitate to contact Julius R. Leiman-Carbia at (202) 272-2824.

Sincerely,

Michael A. Macchiaroli

Associate Director


1 17 C.F.R. §§ 240.17a-3 & 240.17a-4.

2 See 17 C.F.R. § 240.17a-4(a).

3 See 17 C.F.R. § 240.17a-4(b).

4 17 C.F.R. § 240.17a-4(d).

5 Securities Exchange Act Release No. 8,875 (April 30, 1970), 35 Fed. Reg. 7,643 (May 16, 1970).

6 17 C.F.R. § 240.17a-4(f).

7 Letter to Mr. Robert F. Price, Alex.Brown & Sons, from Nelson S. Kibler, Assistant Director, Division of Market Regulation, Commission (November 3, 1979).

8 As each bit (a bit of digital information is indicated as a 0 or 1 — designating an "on" or "off" condition, respectively) of digital information is recorded on the optical medium, the reflective surface of the medium is either permanently altered by the laser heat source to indicate the bit is "on," or not altered to indicate the bit is "off." The permanent alterations, or lack thereof, in the reflectivity of the recorded locations on the medium are then used to read back the information by means of a low powered laser light source. The laser light source detects the change in the reflectivity level of a location on the medium which signifies the "on" or "off" condition of a bit of digital information.

9 According to the SIA, microfilm or microfiche copies are often not as clear as optical disk copies and usually take a longer time to produce.

10 15 U.S.C. § 78q(a)(1).

11 17 C.F.R. §§ 240.17a-3 & 240.17a-4.


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