84 FR 7945 - Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving Proposed Rule Change Relating to FINRA Rule 4570 (Custodian of Books and Records)

[Federal Register Volume 84, Number 43 (Tuesday, March 5, 2019)]
[Notices]
[Pages 7945-7948]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2019-03879]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-85209; File No. SR-FINRA-2018-039]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving Proposed Rule Change Relating to FINRA 
Rule 4570 (Custodian of Books and Records)

February 27, 2019.

I. Introduction

    On November 15, 2018, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``Commission''),

[[Page 7946]]

pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change to: (1) provide a member that is filing a Form BDW (Uniform 
Request for Broker-Dealer Withdrawal) the option of designating another 
FINRA member as the custodian of its books and records on the form; (2) 
clarify the obligations of the designated custodian; and (3) require 
the designated custodian to consent to act in such a capacity. The 
proposed rule change was published for comment in the Federal Register 
on November 30, 2018.\3\ On January 11, 2019, the Commission extended 
until February 28, 2019 the time period to approve the proposed rule 
change, or institute proceedings to determine whether the proposed rule 
change should be disapproved.\4\ The Commission received one comment 
letter on the proposed rule change.\5\ FINRA submitted a response to 
the comment on February 26, 2019.\6\ This order approves the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 85646 (Nov. 30, 
2018), 83 FR 61689 (``Notice'').
    \4\ See Securities Exchange Act Release No. 84982 (Feb. 4, 
2019), 84 FR 1525 (``Extension'').
    \5\ See letter to Robert W. Errett, Deputy Secretary, 
Commission, from Richard J. O'Brien, Senior Vice President, 
Compliance, National Financial Services LLC, dated February 5, 2019 
(``NFS Letter'').
    \6\ See letter to Brent J. Fields, Secretary, Commission, from 
Julia Bogolin, FINRA, dated February 26, 2019 (``FINRA Response'').
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II. Description of the Proposal

    Pursuant to Rule 17a-4 (Records to be Preserved by Certain Exchange 
Members, Brokers and Dealers) under the Exchange Act,\7\ broker-dealers 
are required to retain their books and records for specified retention 
periods.\8\ Paragraph (g) of Rule 17a-4 \9\ provides that an entity 
that stops doing business as a registered broker-dealer has a 
continuing obligation to preserve its required books and records for 
the remainder of the specified retention periods. Form BDW requires 
that a firm that is withdrawing its registration identify and provide 
the contact information of the person who will have custody of the 
firm's books and records after the firm has discontinued its business 
operations. Form BDW also requires that the firm provide the address 
where the books and records will be located, if different than the 
custodian's address. In addition, the Form BDW provides that the firm 
and person signing the form on behalf of the firm must certify that the 
firm's books and records will be preserved and made available for 
inspection.
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    \7\ 17 CFR 240.17a-4.
    \8\ See also FINRA Rule 4511 (General Requirements).
    \9\ 17 CFR 240.17a-4(g).
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    Currently, FINRA Rule 4570 requires a member firm to designate as 
the custodian of its required books and records on the Form BDW a 
person who is associated with the firm at the time the Form BDW is 
filed.\10\ FINRA has noted that the current rule is intended to enhance 
the ability of FINRA to obtain a firm's required books and records upon 
dissolution of the firm.\11\
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    \10\ For purposes of FINRA's rule, an associated person is a 
natural person. See FINRA By-Laws, Article I, paragraph (rr).
    \11\ FINRA has jurisdiction over, and has the ability to obtain 
information from, a former associated person of a member for 
generally two years after: (1) The effective date of the person's 
termination of registration; (2) the effective date of revocation or 
cancellation of the person's registration; or (3) in the case of an 
unregistered person, the date upon which such person ceased to be 
associated with the member. See FINRA By-Laws, Article V, Section 4 
(Retention of Jurisdiction) and FINRA Rule 8210 (Provision of 
Information and Testimony and Inspection and Copying of Books).
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A. Permitting Another Member To Act as the Designated Custodian

    To provide greater flexibility to its members, FINRA has proposed 
to amend Rule 4570 to provide a member that is filing a Form BDW the 
option of designating another FINRA member as the custodian of its 
books and records on the Form BDW. The proposed rule change would not 
require members to designate another FINRA member as the custodian of 
their books and records, but would give them the option to do so, at 
their discretion.

B. Clarifying the Obligations of the Designated Custodian

    In addition to permitting another member to act as the designated 
custodian, FINRA has proposed to amend Rule 4570 to clarify the 
obligations of the designated custodian. Specifically, the proposed 
rule change would clarify that the custodian designated on the Form BDW 
must preserve books and records on behalf of the member that filed the 
Form BDW for the remainder of the applicable retention periods and make 
them available for inspection by FINRA upon request. Further, FINRA's 
proposed rule change would clarify that a custodian is required to 
preserve and produce a former member's books and records in the same 
manner in which they were received. However, the proposed rule change 
would provide that a custodian would not be precluded from converting 
the books and records in its possession into another format acceptable 
under the Exchange Act (e.g., convert from paper format to an 
electronic storage media), so long as such records are not altered or 
deleted during the conversion process.
    In addition, the proposed rule change would provide that where a 
member is acting as custodian, such member would not be required to 
verify the completeness or accuracy of the books and records that it 
receives.\12\
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    \12\ However, FINRA believed that an associated person who is 
acting as custodian of a member's books and records is in a position 
to verify the completeness and accuracy of the member's books and 
records based on his or her existing relationship with the member.
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    Further, FINRA has proposed to amend Rule 4570 to require that 
where a FINRA member has agreed to act as custodian of the books and 
records of another member that has filed a Form BDW, the member acting 
as custodian must: (1) Treat such books and records as if they were its 
own books and records; and (2) arrange upon its dissolution for such 
books and records to continue to be retained for the remainder of the 
applicable retention periods under FINRA and Exchange Act rules in the 
same manner as its own books and records consistent with Rule 4570.

C. Requiring the Consent of the Designated Custodian

    FINRA's proposed rule change would also require a member to obtain 
the affirmative, written or verbal, consent of the custodian of books 
and records identified in the firm's Form BDW. In addition, the 
proposed rule change would require a member that is withdrawing its 
registration to inform its custodian of the obligations under FINRA and 
Exchange Act rules, including FINRA Rule 4570, prior to obtaining the 
custodian's consent. The proposed rule change would also require the 
designated custodian to represent to FINRA, in a method prescribed by 
FINRA, that the custodian: (1) Has consented to act in the capacity of 
a custodian; (2) understands the responsibilities of a custodian; and 
(3) agrees to provide the books and records of the member for which it 
is acting as custodian to FINRA upon request during the course of the 
required retention periods.
    FINRA has stated that it will announce the effective date of the 
rule change in a Regulatory Notice to be published no later than 60 
days following a Commission approval, and the effective date will be no 
later than 120 days following publication of that Regulatory 
Notice.\13\
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    \13\ See Notice, 83 FR at 61690.

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[[Page 7947]]

III. Summary of Comment and FINRA's Response

    The Commission received one comment letter regarding the 
proposal.\14\ The commenter generally believed that the proposed rule 
would place undue financial and operational burdens on clearing 
firms.\15\ More specifically, the commenter warned that there are far 
fewer fully disclosed clearing firms that could act as custodians for 
purposes of the rule change than FINRA indicated, and that therefore 
the resulting burden on competition would not be reasonable and 
appropriate.\16\ Furthermore, the proposed rule requirement for a 
custodian to treat the withdrawing firm's books and records as if they 
were the custodian's own ``would add to a clearing firm's existing 
complex and voluminous record storage practice'' and would require 
``sizable additional technology and human resources, not to mention the 
costs of paying for additional storage.'' \17\ The commenter also 
warned that, as custodian of a BDW firm's books and records, it would 
be subject to additional regulatory requests and potentially become the 
subject of litigation, if either it must retain books and records for a 
longer period of time due to a litigation hold or if it becomes the 
logical defendant for an end customer with a grievance deciding to 
pursue litigation after their introducing firm has filed a BDW.\18\ 
Despite these ``significant regulatory and litigation burdens,'' the 
commenter noted that it would be unpractical to expect correspondent 
clients to pay for the additional costs, because ``clearing firms will 
have little leverage to force such an additional cost'' and introducing 
broker-dealers are ``looking to reduce costs and increase efficiency 
and it is unlikely that they would agree to pay in advance for a 
service that would be necessary only in a worst-case scenario, which 
they do not believe will ever occur.'' \19\ Finally, the commenter 
stated that if the Commission approves the proposed rule change, the 
rule should be modified as follows: (1) The rule should require written 
consent from the person identified as custodian on the firm's BDW; (2) 
clearing firms must be granted limitations on liability under the rule 
with respect to recordkeeping or related deficiencies that are 
attributable to the withdrawing broker-dealer; and (3) the Commission 
should consider enacting a rule to provide for a comprehensive and 
orderly process for unwinding a broker-dealer.\20\
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    \14\ See supra note 5.
    \15\ See NFS Letter at 1.
    \16\ See id. at 2.
    \17\ See id. at 3.
    \18\ See id. at 3-4.
    \19\ See id.
    \20\ See id. at 5-6.
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    In its response letter, FINRA clarified that the proposed rule 
change ``would have no impact on clearing firms or any other firms or 
individuals that choose not to consent to becoming a Rule 4570 
custodian for another firm.'' \21\ FINRA also acknowledged that a 
member that chooses to assume the role of custodian would likely incur 
additional costs, but noted that FINRA ``expects that a member would 
weigh the extent of the burden and ability to recover costs in 
determining whether to consent to become a custodian of books and 
records.'' \22\ In addition, FINRA stated that it developed the rule 
change ``in response to feedback from some members that expressed 
difficulty in identifying and designating an associated person as the 
books and records custodian on their Form BDW'' and that these members 
``indicated that other members are willing to function as custodians 
for purposes of FINRA Rule 4570, but they cannot do so currently 
because of the limitations in the rule.'' \23\ Furthermore, FINRA noted 
that it vetted the proposed rule change with several of its advisory 
committees, including the Clearing Firm Advisory Committee, and that 
``ultimately each committee supported the Proposal going forward, given 
its optional nature.'' \24\ Furthermore, FINRA stated that the 
commenter ``provided no basis for its contention that it will be 
`pressured' to take on the custodian role without compensation'' and 
that FINRA believed that ``market forces will determine whether a third 
party will consent to acting as custodian.'' \25\ In addition to 
clarifying the number of clearing firms that appear to have fully 
disclosed relationships with introducing broker-dealers,\26\ FINRA also 
clarified, with respect to the commenter's modifications to the 
proposal, that: (1) Oral consent is an option under the proposed rule 
because ``sometimes firms wind down business operations under expedited 
circumstances,'' but there is nothing in the proposed rule that would 
prevent a clearing firm from ``having an internal policy that would 
require written consent be given'' in order to establish the required 
consent; and (2) the proposed rule did not contemplate that a member 
acting as custodian ``would be liable for deficiencies in the records 
that it receives,'' but ``any limitations on liability that would 
affect the maintenance, preservation or availability of the records 
received by the custodian would be contrary to the purpose of the 
rule.'' \27\
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    \21\ See FINRA Response at 1.
    \22\ See id. at 1-2.
    \23\ See id. at 2.
    \24\ See id.
    \25\ See id.
    \26\ See id. at 2-3.
    \27\ See FINRA Response at 3.
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IV. Discussion and Commission Findings

    After careful consideration of the proposal, the comment submitted, 
and FINRA's response to the comment, the Commission finds that the 
proposed rule change is consistent with the requirements of the 
Exchange Act and the rules and regulations thereunder applicable to a 
national securities association.\28\ In particular, the Commission 
finds that the proposed rule change is consistent with Section 
15A(b)(6) of the Exchange Act,\29\ which requires, among other things, 
that FINRA rules be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
and, in general, to protect investors and the public interest.
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    \28\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \29\ 15 U.S.C. 78o-3(b)(6).
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    The Commission believes that the proposal is reasonably designed to 
facilitate compliance with recordkeeping requirements pursuant to FINRA 
rules and the Exchange Act. First, the proposed rule will provide 
greater flexibility for members, particularly introducing-only firms 
with established relationships with clearing firms, as FINRA has stated 
that some members have had difficulty in identifying and designating an 
associated person as the books and records custodian on their Form BDWs 
when they are in the process of winding down. This change will also 
enhance FINRA's ability to obtain the member's required books and 
records upon the member's dissolution, as FINRA's jurisdiction over 
former associated persons is more limited than its jurisdiction over 
current members. Second, the proposed rule change will clarify the 
obligations of the designated custodian to ensure that the custodian is 
preserving the former firm's books and records for the applicable 
retention periods. Such clarification will help ensure that the former 
firm's books and records are available for FINRA staff to conduct its 
work and so that customers who wish to bring a claim against the firm 
are not unnecessarily limited in their ability to obtain restitution. 
Third, the proposed rule change will require

[[Page 7948]]

the designated custodian to consent to act in such a capacity, which 
will address the potentially problematic situation where the person 
named as the custodian on the Form BDW was not aware that the member 
was designating the person as a custodian and did not have access to 
the former firm's books and records. Furthermore, given the optional 
nature of the proposed rule change, the Commission has no reason to 
believe that this proposal will impose undue burdens on FINRA member 
firms.
    The Commission acknowledges the concerns of the commenter who 
argued that ``a considerable amount of work'' would be required of a 
clearing broker-dealer that agrees to be designated as a custodian 
under the proposed rule change and that such firm would bear additional 
financial and operational costs.\30\ The Commission believes, 
nevertheless, that the comment does not preclude approval of the 
proposal. The proposed changes to FINRA Rule 4570 would permit, but not 
obligate, a member firm to take on the responsibilities associated with 
being designated as a custodian by another FINRA member on the Form 
BDW.\31\ This change will allow member firms that have already 
indicated their willingness to be named as custodian for other broker-
dealers the ability to be designated as such. The Commission also notes 
that FINRA vetted the proposal with several advisory committees, 
including the Clearing Firm Advisory Committee. These committees would 
be aware of the concerns expressed by the commenter, but they supported 
the proposal given its optional nature. With respect to the commenter's 
assumption that the costs for custodial services provided by clearing 
firms could not be priced into contracts with introducing broker-
dealers, the commenter did not offer data or other analysis to support 
its position. In the absence of such data or analysis, and given that 
the proposal does not create any mandate for any member to become a 
custodian of books and records of another member, it is difficult for 
the Commission to understand the commenter's contention that the 
proposed rule change would impose substantial operational and financial 
burdens on clearing firms. The Commission further notes that the 
optional nature of the proposed rule change would permit a clearing 
firm to avoid taking on the responsibilities and burdens associated 
with becoming a custodian for an introducing member until such time 
that the market allows it to price such custodial services into its 
contracts with introducing firms.
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    \30\ See NFS Letter at 1-2.
    \31\ See Notice, 83 FR at 61690.
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    The Commission also acknowledges the commenter's requested 
clarifications to the proposed rule change.\32\ The Commission notes 
that while the proposal requires that the broker-dealer filing the Form 
BDW receive written or oral consent from the custodian, it also 
requires that the custodian follow up with a written confirmation to 
FINRA stating that the custodian agrees to this designation and that it 
understands its obligations under the rule.\33\ This second step 
effectively ensures that there is written confirmation from the 
custodian before it can be designated as such. Furthermore, the 
Commission notes that the current proposal makes clear that any member 
firm that undertakes custodial responsibilities for another member firm 
would not be expected to verify the completeness or accuracy of any 
books and records it receives as part of its custodial duties.\34\ 
However, the Commission believes that a limitation on liability with 
respect to the custodian's maintenance or preservation of records would 
frustrate the policy objectives of Rule 17a-4 under the Exchange Act 
and FINRA Rule 4570.
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    \32\ See NFS Letter at 5-6.
    \33\ See Notice, 83 FR at 61690.
    \34\ See id.
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    As discussed above, the proposed rule change will facilitate 
compliance with recordkeeping requirements for member firms and 
preserve FINRA's ability to have jurisdiction over, and obtain 
information from, the member that has agreed to act as custodian.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\35\ that the proposed rule change (SR-FINRA-2018-039) is 
approved.
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    \35\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\36\
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    \36\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-03879 Filed 3-4-19; 8:45 am]
 BILLING CODE 8011-01-P