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SEC rule changes: Will brokers and dealers finally embrace optical storage?

This article appears in the issue April 1999 [Volume 8, Issue 4]

In June 1993, the U.S. Securities & Exchange Commission (www.sec .gov) recognized the advantages of using storage technology in the securities industry by issuing a "no action" letter that allowed members, brokers or dealers (brokers/dealers) to use optical storage technology for record retention purposes. The letter set forth requirements that brokers/dealers needed to meet if they chose to use optical storage technology to comply with Rules 17a-3 and 17a-4, which deal with retention of records.

The "no action" letter offered brokers/dealers a more cost-effective way of storing documents than the traditional methods of storing documents, such as microfiche. But brokers/dealers have been slow to accept the concept of electronically storing documents, especially trade tickets. In a further attempt to prod brokers/dealers into taking advantage of the process efficiency and cost savings available with storage technology, the SEC in April 1997 issued an amended Rule17a-4, which included the idea of the "no action" letter.

The key change is to allow additional technologies, not just optical disc technology, to be used for record retention purposes. However, it should be noted that the amendment still effectively limits a broker/dealer's choice to optical imaging because the electronic media must be non-erasable or write once-read many (WORM). Although brokers/dealers must also meet certain additional requirements in order to use storage technology for record retention purposes, they stand to benefit significantly from reduced costs and increased efficiency.

SEC Rules 17a-3 and 17a-4 set record retention standards for brokers/dealers. Rule 17a-3 spells out which records brokers/dealers must keep current, including trade tickets, daily transaction ledgers and blotters, memoranda of brokerage orders, confirmations of all purchases and sales of securities, records of all puts, calls, spreads, straddles and other options, trial balances of accounts and applications for employment.

Rule 17a-4 specifies how long those records must be kept-depending on the type of record, either three or six years, with the first two years in an easily accessible place. It also spells out acceptable methods of storage.

Those rules were easy to understand but as originally written, did not recognize the cumbersome and costly nature of the task they imposed on brokers/dealers.

Made aware of that burden, the SEC issued the original "no action" letter and now the current amendment to Rule 17a-4 in order to encourage firms to seek the process efficiency and cost savings attainable through electronic storage technology.

While it might seem logical that affected firms would embrace the amendments and switch to storage technology while singing the praises of the SEC, that has not happened. Many brokers/dealers have not yet bought the concept and still tend to focus only on the disadvantages of storage technology. Those who believe that the disadvantages outweigh the advantages, even in the short term, may be making a mistake. They may be overlooking some of the advantages of storage technology or may not realize that many past disadvantages have been overcome.

Weighing the pluses and minuses

The pluses include:

  • process efficiency-Optical systems offer high capacity and automatic handling capabilities, which provide quick mounting and dismounting of data for near-online information. As a result, optical storage technology could increase productivity throughout the organization.
  • data integrity-If set up appropriately, an optical storage system can strengthen data integrity by ensuring that media are not erasable and that there are safeguards to prevent accidental destruction.
  • durability-Optical discs are durable, with a storage life of 20 years, and can be read thousands of times without any wear. They are considered to be very stable and will suffer no degradation due to storage, age or frequency of use.
  • storage cost reduction-An optical storage jukebox can hold 128 platters-the equivalent of 500 four-drawer file cabinets. As a result, optical discs can save a broker/dealer thousands of dollars in storage costs by reducing rent expenses and archiving costs to outside vendors. For brokers/dealers in New York City and other high-cost areas, that should really hit home. In addition, if a multifunctional approach is chosen (optomagnetic technology provides the capability to segment rewritable media from WORM media), the technology can eventually be used to replace the practice of recording data to magnetic tape.
  • ease of locating imaged documents-Storing documents on optical discs makes them easy to find and greatly reduces the likelihood of lost documents, because imaged documents cannot be misplaced.
  • no more fiche-Fiche can be tampered with and easily destroyed and tends to deteriorate with handling. Copies made with fiche are usually not of high quality, and working with fiche tends to be rough on the eyes. Further, it can take up to 10 times (and this may be conservative) as long to find a fiched document as opposed to finding an imaged document.
  • use of imaging in other critical broker/dealer areas-Optical storage technology is flexible and can be put to multiple uses. A broker/dealer can leverage optical storage technology to increase productivity and cut storage costs in other areas of the firm. Quite apart from its role in complying with SEC record retention requirements, properly implemented imaging technology can enable the firm to re-engineer its overall workflow to increase efficiency and employee productivity and reduce storage costs.

The minuses include:

  • cost-Although optical imaging can save a company money in the long run, it requires a relatively high initial investment. The firm will initially incur costs related to new hardware and software required, placing all of its currently held hard-copy documents onto the system, and employee training.
  • no standards-Optical imaging systems have yet to reach a level of standardization, and off-the-shelf products often do not meet the needs of brokers/dealers. As a result there is a high degree of customization involved.

Disadvantages aside, the upside to optical storage technology is huge for brokers/dealers, who must satisfy SEC and IRS requirements, and yearn to re-engineer their workflow for optimum process efficiency. The fact is that over the long run, optical imaging technology can offer large savings in tangible costs, such as the reduction of storage and space costs, as well as in less tangible areas, such as employee productivity.

Brokers/dealers can reap many benefits by switching to optical storage technology, but it may not be the best means of storage for every company. An educated decision is required, and that depends on understanding all of the benefits and drawbacks. By any realistic measure, the advantages of optical imaging technology solidly outweigh the disadvantages-disadvantages that typically apply to any new technology.

Some considerations

A broker/dealer must consider a number of issues before deciding to modernize and implement an electronic record retention system. First, the organization must consider the type of technology that best meets its purposes. There are several acceptable technologies, but many different providers and few standards in place.

The firm's existing system architecture must also be considered, since all multiuser optical storage systems must be tied to the current architecture through communication networks-i.e. local area networks (LAN), wide area networks (WAN), satellite links or fiber optical channels. The type of communication network depends on the application's requirements, the location of the potential users and whether the system will need to work with other systems.

The design of the communications system is critical to performance, because shipping large images across a network can significantly slow response time if not set up appropriately.

A second consideration is that the proper level of internal controls must be in place, particularly data security controls. The requirements for brokers/dealers, who are using optical imaging technology for SEC rules 17a-3 & 4, specifically relate to internal controls. Therefore, to be in regulatory compliance with the SEC, optically stored documents must have adequate information protection controls safeguarding them.

Controls become even more important when one considers that many recent court decisions have not been concerned with the type of media used, but have focused instead on the manner in which the data was handled and controlled. Specifically, the firm needs to establish adequate controls over physical access to both archived and on-site optical discs, as well as scanners, workstations and hardware (including the jukebox).

Also, logical access controls must be in place to ensure that data is protected from unauthorized modifications, that documents are secure from deletion, that the system establishes individual accountability for actions, and that any unauthorized activities or events are reported.

A third consideration deals with the proper indexing of documents for easy and quick retrieval. Procedures need to be in place to ensure that records are organized and indexed accurately, that discs are serialized and date stamped, and that the indexed records can be readily downloaded.

The SEC requires that brokers/dealers store duplicate copies of discs separately from the originals. That is to ensure the availability of records in the event of a disaster, or in case of unintentional destruction of the original. Therefore, another consideration should be a comprehensive disaster recovery plan that encompasses the entire optical imaging system and process. In general, a business impact analysis must drive a broker/dealer's recovery strategy. The recovery strategy for resuming business must take into account both the financial and the operational impact of computer system outages, as well as the broker/dealer's ability to continue essential business functions while the system is inoperable. A comprehensive business resumption and disaster recovery plan could include duplexed hardware, timely stored off-site data, periodic testing and the ability to recreate its customized optical storage programs.

The use of imaging technology raises a great many issues-among them the cost of implementation, auditability, security and recovery. With proper management of those issues, optical storage technology offers brokers/dealers a more cost-effective way to keep current and efficient records and can lead to valuable process efficiencies. It can also offer productivity and efficiency gains, which can be seen not only as cost reductions but as competitive advantages in today's increasingly contested and price-sensitive markets.

The SEC regulations have once again called attention to the advantages offered by optical storage technology. Whether that will lead more firms to embrace it remains to be seen.


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