Books and Records Requirements for Broker Dealers

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Books and Records Requirementsfor Broker Dealers
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Examination Authority

• The cornerstone of any examination is formed by
  reviewing the firms books and records as well as
  the firms supervisory procedures.
• States statutes and regulations provide them
  with the authority to examine and request the
  production of the firms books and records.
• The requirement to create and/or maintain books
  and records can be found in SEC Rules 17a-3 and
  17a-4 and NASD Conduct Rule 3110.

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Examination Authority

• 17a-3 identifies records that B/Ds must create
  and keep current as they relate to the individual
  B/Ds business.
• 17a-4 identifies records that must be maintained
  and preserved.
• Most records must be maintained for three to six
  years.
• The two most recent years must be maintained in
  an easily accessible area pursuant to 17a-4(a).
  Generally, these records are maintained on site.

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SEC Rules 17a-3 and 17a-4

• On May 2, 2003, the first substantive amendments
  to these rules in over 30 years became effective.
• The purpose of these amendments was to provide
  regulators with ready access to records, thereby
  allowing regulators to conduct more efficient and
  effective sales practice examinations.

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SEC Rules 17a-3 and 17a-4

• The amendments to Rule 17a-3 include
  requirements to
• Create records relating to associated persons
  (17a-3(a)(12))
• Collect certain account information and verify
  that information with customers periodically
  (17a-3(a)(17)(i)(A))
• Create a record of customer complaints
  (17a-3(a)(18)(i))
• Create a record indicating compliance with
  advertising rules (17a-3(a)(20))
• Identify the person responsible for policies and
  procedures (17a-3(a)(22)) and designate a person
  who can explain the B/Ds records (17a-3(a)(21))
• Revise information required on order tickets
  (17a-3(a)(6) and (a)(7)).

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SEC Rules 17a-3 and 17a-4

• The rules require the maintenance of both home
  and local office records. Prior to this time
  there were no local (or branch) office record
  requirements pursuant to the provisions of the
  National Securities Markets Improvement Act of
  1996 (NSMIA).
• B/Ds are required to produce records at offices
  within the state. Agreement of time for extensive
  request

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SEC Rules 17a-3 and 17a-4

• Local office is defined as any location, other
  than the home office, where one or more
  associated persons (registered representatives)
  regularly conduct the business of handling funds
  or securities or effecting any transaction in or
  inducing or attempting to induce the purchase or
  sale of any security by any means (17a-3(h)(1)).

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SEC Rules 17a-3 and 17a-4

• There are certain exemptions to the locations
  including some private residences and bank broker
  dealer circuit riders. SEC Rule 17a-4(I).

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SEC Rules 17a-3 and 17a-4

• Local office records must be maintained at the
  local office or be promptly delivered to local
  offices.
• The term promptly is not specifically defined
  and is left up to negotiation between the firm
  and examiners. However, if records are on site
  they should be provided immediately for
  inspection. Discuss 24 hour timeframe.

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Record Maintenance

• 17a-4
• Records are not required to be maintained in any
  particular form, as long as they are sufficient
  to provide an audit trail.
• Record maintenance may include paper, electronic,
  optical image (disk), micrographic media a/k/a
  microfilm/fiche, etc.
• Optical image uses WORM technology (Write Once,
  Read Many)
• Electronic records must be print or copy capable.

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Examinations

• Each brokerage firm is required to maintain
  certain books and records at its home office.
• However, most of your examinations will involve a
  review of the operations of a firms branch or
  local office.

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Required Broker DealerBooks and Records
So, what records are brokerage firms required to
maintain?
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Required Broker DealerBooks and Records

• Written Supervisory Procedures
• These procedures instruct the agent and the
  manager how to carry out their day to day actions
  and activities.
• This document will help the examiner understand
  how the firm conducts its business.
• Written supervisory procedures must be maintained
  for a period of three years after the termination
  of each manual, update, modification and
  revision. SEC Rule 17a-4(e)(7)

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Exception Reports

• SEC Rule 17a-4(e)(8)
• The rule does not require the creation of
  exception reports as part of a supervisory
  program. However, if the firm creates the report
  (for supervisory or operational purposes) the
  report must be maintained for 18 months.
• If the report is maintained electronically, the
  firm must be able to reproduce the report.

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Regulatory Mandated Reports/ Internal Audit
Reports

• Regulatory settlements may require firms to
  contract with independent consultants to conduct
  internal audits. These independent consultant
  reports are required to be maintained and
  provided to regulators, if requested. SEC Rule
  17a-4 (e)(6).

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Regulator Mandated Reports/ Internal Audit Reports

• Internal (branch) audits not mandated by
  settlements are not required pursuant to this
  rule. However, firms are required to conduct
  internal audits in order to comply with
  supervisory requirements.

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Required Broker DealerBooks and Records

• Customer Complaints- SEC Rule 17a-3(a)(18)
• Each firm is required to maintain a record of all
  complaints filed against its agents.
• If possible, examiners should review the
  allegations contained in each complaint,
  regardless of the state the client was from, to
  determine if there is a pattern of abuse and the
  firms response to the complaint.
• In lieu of the customer complaint being
  maintained at the branch or local office, the
  firm may maintain a complaint log.
• The log should include complainants name,
  address, account number, date received,
  registered reps name, description of complaint
  and resolution.

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Required Broker DealerBooks and Records

• Associated Person Records
• These are, essentially, agents personnel files.
  They contain registration, disciplinary, and
  continuing education material. They will also
  contain the records of individuals that are no
  longer with the firm for at least three years
  after the associated persons termination. (Form
  U-4 Registration / Form U-5 Termination Notice)
• Firms must maintain
• Copies of all compensation and other agreements
  with associated persons. These records include
  employment agreements, independent contractor,
  and franchise agreements. SEC Rule
  17a-3(a)(19)(ii)
• Employment application i.e., Form U-4 (FINRA
  letter approved by SEC), CRD number and record
  identifying internal identification record. (Jane
  Doe, CRD Number 12345, Rep. No. 155) SEC Rule
  17a-3(a)(12).

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Required Broker DealerBooks and Records

• Customer Correspondence
• The firm is required to maintain any customized
  correspondence between an agent and his clients
  relating to a firms securities business,
  regardless of form (ex. paper, fax, e-mail). Firm
  sales literature and pre-approved form letters
  will not appear in this file.

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Required Broker DealerBooks and Records

• The correspondence does not have to be contained
  in a centralized location. Some firms have a
  centralized correspondence file, while others
  file the correspondence in the appropriate
  clients account file. Either is acceptable.
• NASD Conduct Rule 3010 requires that each dealer
  establish procedures whereby a representative
  sample of e-mails be reviewed by management.
  (NASD Notice to Members 98-11) Most firms have
  adopted review parameters of 10 to 25.
• All correspondence, written or electronic, must
  evidence approval by a principal or manager. SEC
  Rule 17a-4(b)(4).

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Required Broker DealerBooks and Records

• Advertising and Sales Literature
• Each item of advertising or sales literature must
  be approved by the firm prior to its use.
• In certain instances, FINRA approval is required
  within 10 days of first use.
• Advertising is defined as material published or
  designed for use in a newspaper, magazine, or
  other periodical a radio, television, telephone
  or video recording a sign, billboard or other
  public media.

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Required Broker DealerBooks and Records

• Sales literature is any written or electronic
  communication made available to customers or the
  public. (e.g., circulars, research reports, form
  letters, scripts, seminar texts or published
  articles.)
• All advertising and sales literature must be
  true, accurate, and presented fairly.
• All advertising and sales material must evidence
  approval by a principal or manager. SEC Rule
  17a-4(b)(4).

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Required Broker DealerBooks and Records

• Record of Compliance
• Requires the firm to demonstrate, either by the
  record itself or a separate record, that they
  have adopted policies and procedures reasonably
  designed to establish compliance with rules
  relative to marketing materials, advertising,
  electronic communications sales literature, sales
  scripts and any other form of communication, etc.
  SEC Rule 17a-3(a)(20)

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Required Broker DealerBooks and Records

• Customer Account Record/File
• The customer file generally contains a customers
  new account record (form), which captures the
  clients financial and tax status and their
  investment objectives, and all other documents
  used to open the account. (i.e., margin
  agreement, options agreement, discretionary
  trading authority, limited power of attorney,
  etc.) The form must be approved or accepted by a
  principal of the B/D.

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Required Broker DealerBooks and Records

• SEC Rule 17a-3 (a)(17) requires for every natural
  person maintaining an account for which a
  suitability determination is to be made pursuant
  to SRO suitability rules, the firm must maintain
  new account information and update at least once
  every three years. Upon opening or updating an
  account, the firm, within 30 days, must provide
  the account information, new account card or like
  facsimile to the customer. The firm must also
  provide to each customer a plain English
  definition(s) of the firms investment
  objectives, time horizon and risk tolerance.

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Required Broker DealerBooks and Records

• Finally, the firm must provide the customer,
  presumably on the new account (or like facsimile)
  or customer statement, the name(s) and
  address(es) and phone number, of where to direct
  customer complaints (17a-3(a)(18)).
• If customers of the office have indicated
  inaccuracies on their account information, the
  examiner should discuss with the manager the
  means by which the firm has addressed the
  customers concerns.

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Required Broker DealerBooks and Records

• If after the account is established the agent
  becomes aware of the need to update the account
  information the agent should update the account
  record to reflect the changes. The firm must
  then provide the customer with the information
  via a negative consent letter instructing them
  to review the changes and, if inaccurate return
  the corrected information to the Compliance
  Department.
• Additionally, the firm must provide the customer
  with copies of agreements, including margin,
  arbitration, option, discretionary, etc.

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Required Broker DealerBooks and Records

• Special attention should be paid to the
  registered representatives for which inaccurate
  client information (income, net worth, investment
  objectives) or repetitive problems are prevalent.
• As stated in Rule 17a-3(a)(17)(i)(B)(1), B/Ds
  must create a record indicating that the B/D
  furnished customers with a copy or like facsimile
  of their new account/update information.

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Required Broker DealerBooks and Records

• Commission Statements or Commission Runs
• An examiner can determine the commissions being
  paid to specific agents from specific client
  accounts.
• An examiner can observe the differences in the
  commission payout structure along a firms
  product line.
• An examiner can determine whether a manager
  spends most of his/her time managing as opposed
  to selling.
• Rule 17a-3(a)(19)(i) requires a BD to make a
  record listing each associated persons purchase
  and sale of a security attributable to that
  associated person, allowing regulators to quickly
  identify compensation trends.
• Records must include
• Amount of compensation including monetary
  (commissions, concessions, overrides) and
  non-monetary (sales incentives, gifts, trips)
  compensation.

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Required Broker DealerBooks and Records

• Purchase and Sales Blotter
• A blotter is another name for a list or log. In
  this case, it is a list of the purchases and
  sales during a particular time period.
• The PS blotter will list the date, customers
  name, account number, name and amount of
  securities, unit and aggregate purchase or sale
  price, and name of person from whom purchased or
  sold. Additional information may be on the
  blotter which may be of use such as time of
  execution, the clients state of residence,
  whether the trade has been canceled and rebilled
  and date of entry for the trade.
• Most blotters are stored electronically and will
  be printed at an examiners request.

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Required Broker DealerBooks and Records

• Order Tickets (17a-3(a)(6) and (a)(7))
• Created by the agent. This is often an electronic
  record.
• Sets forth the terms and conditions of the order.
• Examiners can determine whether the trades were
  solicited by the agent.
• By reviewing the time stamps, an examiner can
  determine when the orders were received.

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Required Broker DealerBooks and Records

• If the order is taken by an individual other than
  the associated person assigned to the account,
  the firm must note the associated persons
  name/Rep. No., on the ticket or an alternative
  document. SEC Rule 17a-3(a)(6).
• Rule 17a-3 and 17a-4 excludes from the definition
  of associated persons anyone whose functions are
  solely clerical or ministerial in nature.

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Required Broker DealerBooks and Records

• An associated person includes any partner,
  officer, director or branch manager of a broker
  dealer (any person occupying a similar status or
  performing similar functions), any person
  directly or indirectly, controlled by, or under
  common control with a broker dealer, or any
  employee of a broker dealer. This includes
  order-takers. The term associated person includes
  any independent contractor, consultant,
  franchisee, or other person providing services to
  a broker dealer equivalent to those services
  provided by the persons specifically referenced
  in the statute.

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Required Broker DealerBooks and Records

• Trade Confirmations
• They are receipts that are mailed to the
  customer after each executed trade
• By reviewing trade confirmations, an examiner can
  determine whether the firm sold the position from
  its own inventory or whether it acquired the
  security from the market. (You may also want to
  ask for the B/Ds trade blotter to review.)
• Commissions will indicate the position was
  acquired from the market.
• Markups will indicate the position was sold from
  the firms inventory.

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Required Broker DealerBooks and Records

• Cash Receipts and Disbursements Blotter
• With this log or list the examiner can determine
  whether customer funds are being promptly
  transmitted to the clearing firm.
• An examiner can ensure that customer checks are
  made payable to the clearing firm. If the checks
  are made to the BD and not the clearing firm,
  check to see if correspondence is being sent to
  the customer to correct this problem.
• Examiners should check this blotter against the
  monthly customer account statements to ensure
  accuracy.

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Required Broker DealerBooks and Records

• Securities Received and Delivered Blotter
• An examiner can determine the stock certificates
  that have been deposited into accounts at the
  firm.
• An examiner can ascertain whether any delivered
  shares were restricted.
• An examiner should be attentive to suspicious
  deliveries of large blocks of a thinly traded
  security.

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Required Broker DealerBooks and Records

• Customer Account Statements
• An examiner is able to review every transaction
  in a customers account.
• An examiner will review transactions to determine
  whether the activity in the customers accounts
  are appropriate in light of the clients risk
  tolerance, financial situation, and investment
  objectives.
• May be maintained in the customers file.
• May be in an electronic format.
• Copies of the customers monthly or quarterly
  account statements may be found in the customer
  files.
• NASAA/SIFMA has issued a brochure to the public
  providing guidance on understanding account
  statements (NASAA Website).

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Required Broker DealerBooks and Records

• Bank Records
• Bank Statements
• An examiner should review
• The firms bank statement(s) to verify the
  amounts of deposits and checks.
• The firms reconciliation of bank statements with
  their checkbook, the object being to verify
  current cash position as of the financial
  statement date.
• Cancelled Checks
• An examiner should inspect a representative
  sample of cancelled checks for double
  endorsements. Double endorsements may indicate
  the presence of forgery and/or theft of customer
  funds.

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Required Broker DealerBooks and Records

• General Ledger
• Reflects all asset, liability, income, expense
  and capital accounts of a firm. Used to prepare
  the trial balance, balance sheets and other
  statements of financial condition.
• Should be current and maintained chronologically
  by account.
• An examiner should compare entries in the general
  ledger with other subsidiary records having
  money balances to ensure the accuracy in
  posting from these records.

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Required Broker DealerBooks and Records

• Trial Balance
• A statement of open debit and credit money
  balances of all general ledger accounts.
• Acts as a check to ensure the accuracy of the
  general ledger accounts and also keeps firms
  informed of their current capital position.
• An examiner should compare the trial balance
  against every account in the general ledger to
  ensure the trial balance is accurate.
• Must be maintained on a current basis and
  prepared at least monthly.

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Required Broker DealerBooks and Records

• Audited Financial Statements
• Must be prepared in accordance with United States
  GAAP.
• If an examiner suspects a problem, the following
  steps may be useful in pursuing the matter
• First, and foremost, collect all of the firms
  financial statements on file and compare them.
  Concentrate on areas that appear to be
  significantly different from the previous years
  statements.

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Required Broker DealerBooks and Records

• Points to consider
• Are the footnotes clear?
• Are there extraordinary items?
• Is the opening equity balance in the Equity
  section equal to the closing balance of the
  Equity section on the previous years statement?
  They should be identical.
• Is the information on each years statement
  presented uniformly?
• Are the same amortization and depreciation
  methods used from year to year?
• After collecting the financial statement, the
  information needs to be verified.
• Ask questions about the entry.
• Collect documentation to confirm the numbers.

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Required Broker DealerBooks and Records

• The Financial Accounting Standards Board has an
  internet site that may assist you.
• www.fasb.org
• If you discover an accountant engaging in
  inappropriate activity, consider contacting your
  states accounting regulator.
• Obtain original documents, invoices, account
  balances, deeds, bank records and reconstruct the
  item(s) in question.
• Be cognizant of a change in auditing firms

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Review of Broker Dealer Books and Records

• It may become necessary to engage a CPA as an
  expert witness to assist you.
• Check to see if your state allows for the hiring
  of a CPA to be an expert witness.

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Recap of Local Office Records Rule 17a-3(g)

• This subsection of the rule identifies the
  records that are required to be maintained or
  produced at a local office upon the request of a
  securities regulatory authority
• 17a-3(a)(1) Sales Blotter
• 17a-3(a)(6) Customer Order Tickets
• 17a-3(a)(7) Proprietary Order Tickets
• 17a-3(a)(12) Customer/Employee Listing

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Recap of Local Office Records Rule 17a-3(g)

• 17a-3(a)(17) Customer Account Information
• 17a-3(a)(18)(i) Customer Complaint Records
• 17a-3(a)(19) Associated Person Compensation
  Records/ Agreements
• 17a-3(a)(20) Record of Compliance
• 17a-3(a)(21) Identification of Records
  Management Person
• 17a-3(a)(22) Identification of Principal
  Responsible for Compliance