Securities And Futures (keeping Of Records) Rules

[Margarita Lovvorn]

17CFR Part 1 Recordkeeping AGENCY: Commodity Futures Trading Commission. ACTION: Final rules. SUMMARY: The Commodity Futures Trading Commission is adopting amendments to the recordkeeping obligations established in Regulation 1.31. Specifically, the amendments will allow recordkeepers to store most categories of required records on either micrographic or electronic storage media for the full five-year maintenance period, thereby harmonizing procedures for those firms regulated by both the Commission and the Securities and Exchange Commission. Recordkeepers will have the flexibility necessary to maximize the cost reduction and time savings available from improved storage technology while continuing to provide Commission auditors and investigators with timely access to a reliable system of records.

On June 5, 1998, the Commodity Futures Trading Commission ("Commission" or "CFTC") published a Federal Register Notice proposing several amendments to the recordkeeping requirements of Commission Regulation 1.31 (the "Proposal").(1) In light of the significant number of Commission registrants that are subject to the recordkeeping requirements of the Securities and Exchange Commission ("SEC"), the Proposal included many provisions similar to those adopted by the SEC in 1997.(2) The Proposal's overall design reflected the Commission's dual goals of "maximiz[ing] the cost-reduction and time-savings arising from technological developments in the area of electronic storage media" and maintaining the type of safeguards that "ensure the reliability of the recordkeeping process.">(3) The comment period on the Proposal originally was due to expire on August 4, 1998. Upon request from the Futures Industry Association ("FIA"), the Commission extended the deadline to August 18, 1998, to encourage comment by interested persons.

The Commission is publishing final rules that respond to comments expressed by industry participants and that track closely the SEC's recordkeeping requirements. While the final rules are similar to the Proposal in most respects, the Commission intends to modify certain staff practices in light of the comments received. The final rules and modifications to staff practices will provide recordkeepers with opportunities to reduce costs and improve both the efficiency and security of their recordkeeping systems by initiating a transition to electronic storage of Commission-required records.

The Commission recognizes the important role improved technology can play in the continued development of the futures industry. Minimizing unnecessary regulatory obstacles to the adoption of improved technology is a goal of industry members, customers, and the Commission. Indeed, the pace of technological changes will require the Commission continually to review the standards articulated in this rule to ensure that the recordkeeping requirements reflect to the extent possible the reality of established technological innovation. The Commission therefore welcomes consultation with industry participants and specific proposals regarding how the regulations might be amended in the future to permit the futures industry to use available technology and to respond to the Commission's legitimate need to have access to complete and accurate records when necessary.

Commission Regulation 1.31 sets forth certain recordkeeping requirements imposed by the CEA and Commission regulations. Subsection (a) describes the general rule. It mandates that all records required to be kept by the Act or Commission regulations ("required records") be maintained for five years and be kept "readily accessible" during the first two years. It also defines the inspection and production rights of representatives of the Commission and the Department of Justice.(4)

Subsections (b) and (c) establish alternative requirements for required records that are stored as reproductions. Recordkeepers that fulfill the conditions for alternative treatment may dispose of original required records. Eligibility for alternative treatment is limited to particular classes of records that are reproduced on microfilm, microfiche, or optical disk. Computer and machine generated records are immediately eligible for reproduction and storage on one of the alternative media. Most other required records become eligible after two years of storage. Trading cards and written customer orders are ineligible; originals must be maintained for the full five-year period. Subsection (c) describes the special inspection and production conditions applicable to recordkeepers that choose to store reproductions rather than original required records.(5)

The Proposal would eliminate the current requirement that the original of most required records be maintained for two years.(6) Immediate storage of reproductions maintained on micrographic or electronic storage media will enable recordkeepers to lower storage costs significantly by discarding original records following the successful storage of a reproduction. Moreover, the Proposal gave recordkeepers increased flexibility in selecting the advanced technology best suited to their business requirements by substituting the less restrictive category "electronic storage media" for "optical disk" in describing the storage media recordkeepers could employ.(7) As a result, recordkeepers may now take advantage of electronic storage technologies such as digital tape.(8)

In addition, consistent with both the SEC's approach and current Commission requirements, the Proposal set forth several conditions on recordkeepers who choose to meet their obligations by retaining reproductions rather than original records including safeguards to ensure timely access to the reproductions and the Commission's ability to maintain its access to required records despite catastrophic events.(9)

The Proposal articulated additional conditions on recordkeepers that choose to meet their obligations by retaining reproductions on electronic storage media rather than micrographic storage media. First, to ensure that there was an effective check on the reliability of the transfer process, the Proposal required electronic recordkeepers to maintain written operational procedures and controls that would provide accountability over both the initial entry of required records to the electronic storage media and the entry of each change made to any such records.(10) Second, due to practical limitations on the Commission's ability to process data stored in the full range of available formats and coding structures on the full range of storage media available to recordkeepers, the Proposal required electronic recordkeepers to provide copies of requested records on "Commission compatible machine-readable media" with the format and coding structure specified in the request.(11)

Third, like the SEC's rules, the Proposal required recordkeepers using electronic storage media to keep available for inspection "all information necessary to access records and indexes maintained on electronic storage media. . . ."(12)

The Proposal contained a final, additional condition on recordkeepers who stored all required records or all of a particular class of required records solely on electronic storage media. To address those situations in which such a recordkeeper was unable or unwilling to provide Commission representatives with an appropriate means to view and copy specified records and failed to maintain or permit inspection of the information necessary to access requested records, the Proposal required such recordkeepers to enter into an arrangement with a third-party Technical Consultant.(13)

The Commission received nine comments on the Proposal. Commenters included the National Futures Association ("NFA"), four designated futures exchanges, two commodity industry associations, and First Options of Chicago, Inc. ("FOC"), a registered futures commission merchant ("FCM"), which submitted two comments.(14) Most commenters praised the Commission for proposing revisions to its recordkeeping requirements. One commodity exchange praised the Proposal for giving recordkeepers "flexibility to use technological advances in the electronic storage media to reduce the costs associated with record retention." (15) A commodity industry association commended the Commission for moving toward a more generic, performance-based approach to the definition of permissible record storage technology. Another commodity exchange agreed that aspects of the Proposal could lead to improvement in both the security and availability of required records. NFA characterized the Proposal as "a significant step in the right direction . . . .(16)

In view of the significant number of firms subject to regulation under both the federal commodity and securities laws, the final regulations recognize the value of maintaining consistency, where possible, between the Commission's approach to recordkeeping and that of the SEC. The regulations do not reflect strict conformity with the regulations the SEC adopted in 1997, however, because the Commission concluded that there were significant differences between the commodities and securities industry that justified retaining certain of its current rules.(17)

The Proposal permitted recordkeepers to transfer most categories of records to micrographic or electronic storage media immediately, eliminating the need to keep original records for two years. However, original trading cards and customer order tickets were required to be maintained for the full five-year period. A majority of commenters cited cost, efficiency and security concerns in questioning why the Commission declined to permit written trading cards and customer orders to be stored electronically. Both commodity industry associations emphasized that firms incur significant costs organizing, indexing, and storing order tickets and trading cards. FOC noted that firms also incur significant costs to retrieve such records, and one exchange estimated that it expended $100,000 each year to retrieve records requested under Commission Regulation 1.31. Commenters also questioned why retention of original trading cards and order tickets is an important element of an effective audit trail for futures transactions, particularly since the SEC permits electronic storage of written trading cards and order tickets. One commodity industry association urged the Commission to "consider whether the high cost and burden of maintaining original written orders and trading cards is disproportionate to the limited use of these documents in enforcement cases."(18)

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