SEC Proposes Changes to Electronic Record Keeping Requirements
As the United States Securities and Exchange Commission seeks to modernize electronic record keeping requirements in a technologically neutral manner, its proposed changes are unclear as to the permitted use of the technology. cloud âor distributed ledger.
On November 18, 2021, the Securities and Exchange Commission (SEC) proposed changes (proposal) to the electronic record keeping requirements applicable to brokers, securities swap brokers (SBSDs) and major participants in securities swaps (MSBSP) ). Comments on the proposal must be received by January 3, 2022.
The proposal would amend the requirements for electronic record keeping and prompt filing of records under the Securities Exchange Act of 1934 (Exchange Act) as follows:
Evolution of “VER”
The current electronic record retention requirements for brokers under Rule 17a-4 (f) of the Exchange Act date back to 1997, and, while believed to be technologically neutral, were then guided by the predominant electronic storage at the time – using optical platters, CD-ROMs or DVDs (collectively, optical discs) (i.e., hardware solutions that permanently “burn” recordings to discs optical). The original requirements, and the WORM format requirement in particular, have therefore been subject to interpretation by the SEC over the years to accommodate evolving systems standards.
For example, in 2003, an SEC interpretation announced that brokers were not required to use optical discs to meet the WORM requirement. Instead, brokers could use a system of “embedded hardware and software codes” that prevents overwriting, deletion or modification of a record during its required retention period, provided the system does not mitigate. not just the risk that recordings could be edited, overwritten or deleted. Then, in 2019, in the press release adopting Rule 18a-6 for SBSDs and MSBSPs, the SEC further refined its interpretation of the requirement of Rule 17a-4 (f) WORM, clarifying that by relying only on “a software solution that prevents overwriting, deletion or modification of a recording during its required retention period would meet the requirements of the rule.” “
The SEC chose not to adopt a WORM requirement under Rule 18a-6 for SBSDs and MSBSPs in 2019, although it did propose one. Instead, ceding to commentators, the SEC acknowledged that SBSDs and MSBSPs may already have electronic record keeping systems that would not meet the WORM requirement, and further stated that it would be more appropriate. address any changes to the WORM requirement under Rule 17a-4 (f) dealt with in a separate regulation. The SEC also clarified that Final Rule 18a-6 (e) would not require the use of a particular electronic storage “medium”, such as optical discs, but instead chose to use the phrase ” electronic storage system âbecause the latter phrase better characterizes a system that produces and preserves records electronically without being unduly prescriptive.
Industry efforts to persuade the SEC to liberalize what have long been seen as technology-specific rules that are outdated and dramatically slow the pace of business adoption of innovative and dynamic communications technology, in favor of ‘a “principled” requirement similar to what has been adopted by the Commodity Futures Trading Commission, are underway. With the recent proposal, the SEC takes a step forward in addressing some of these concerns about the WORM requirement, although it stops before a principled approach.
Cloud-based storage:Even though cloud-based storage solutions have proliferated over the years, the proposal gives little storage space to this innovation. The SEC includes in the proposal a discussion regarding the permitted use of only software-based systems that are designed to comply with Rule 17a-4 (f), and in doing so cites specific cloud-based solutions ( which implicitly would appear to support cloud-based storage); however, the proposal does not explicitly state the authorization to use cloud storage to comply with companies’ record retention and retention obligations. This may be a missed opportunity for the SEC to clarify an issue that many companies may continue to struggle with.
Distributed Ledger Technology: The proposal does not say whether blockchain or other distributed ledger technology could be used to promote business compliance under the proposed changes. Rather than providing clarification to companies, if passed as proposed, the changes will likely cause companies to seek advice from FINRA and the SEC on whether a particular type of technology or vendor is acceptable.
Of course, companies would be required to determine for themselves whether a particular technology is compliant, but it would help the industry for the SEC to provide more specific guidance regarding whether – and the specific circumstances under which – distributed ledger technology is used. can comply with any proposed amendment. Given the growing importance and focus on distributed ledger technology in the financial services industry, It would be appropriate for the SEC to recognize the technology in order to give industry assurance that its use could be compliant as it matures.
Redundancy: The proposal’s requirement that businesses have a second electronic record-keeping ‘system’ that preserves a second set of records that can be viewed and examined if the primary electronic record-keeping system storing the first set of records records are disrupted, malfunction, or become inaccessible can be pragmatic in ensuring that books and records are not entirely lost; however, the SEC provided little justification for requiring the deployment of a second âsystemâ. Industry can benefit from further guidance on what exactly might constitute a separate âsystemâ and whether there are particular configurations of the primary and backup systems that would make the backup system not sufficiently separate. Moreover, although the proposal makes reference to business continuity issues, the proposal does not explain in detail how the current requirement of duplicate registration under the rules has proved insufficient, especially given the FINRA requirements for business continuity plans.
The SEC is to be commended for its efforts to modernize electronic record keeping requirements under Rules 17a-4 and 18a-6 of the Exchange Act. While the proposal seeks to implement a number of important advances, the SEC may seek to take into account some additional considerations before finalizing the proposal.