April 12, 1999 Mr. Jonathan G. Katz Secretary Securities and Exchange Commission 450 Fifth Street, N.W. Washington DC 20549 Re: Release No. 34-41142; File No. S7-8-99 Dear Mr. Katz: The Federal Regulation Committee, the Committee on Technology and Regulation, the Year 2000 Legal and Regulatory Subcommittee, the Capital Committee and the Operations Committee of the Securities Industry Association (“SIA”) appreciate this opportunity to comment on the proposed rule establishing operational capability requirements for registered broker- dealers and transfer agents. The SIA fully supports the Commission's efforts to assure an effective transition by regulated broker-dealers to the Year 2000. Indeed, the SIA has taken the responsibility for organizing the industry-wide effort to alert the brokerage community to this problem, assist them in their remediation efforts, and coordinating the testing of those efforts on an industry-wide basis. Accordingly, the SIA supports, in general, the Commission's view that broker-dealers who have not taken necessary steps to address material Year 2000 problems in mission-critical systems by October 15, 1999, should be precluded from conducting business until they can demonstrate that they have brought themselves into compliance. Below, we offer suggestions for tightening and clarifying the proposed rule language. For example, we suggest that the rule language refer to “material” Year 2000 problems and “mission critical” systems throughout, and that the Division of Market Regulation obtain exemptive authority pursuant to delegated authority. SIA opposes the proposed rule governing general (non-Y2K) operational capability and believes that the problem sought to be addressed by this rule is so significantly removed from Year 2000 operational readiness, that it should be delinked and made the subject of a separate rule filing. SIA and its member firms would welcome the opportunity to work with the SEC on defining general operational capability and developing appropriate guidelines for firms in this area. 1. Because Rule 15b7-2 is not necessary to address the specific issue of Year 2000 readiness, it should not be adopted at this time. Rule 15b7-2 would add a general rule requiring every broker-dealer to have the operational capability "to assure the prompt and accurate" implementation of the many components of a securities business. Unlike the cooperative effort that has characterized the Year 2000 work, these rules have been proposed without consultation or discussion with the industry. The rule text is exceptionally broad in its scope and would represent an extraordinary grant of discretionary power to the Commission to take drastic action in circumstances that appear to be open to subjective interpretation. In the introductory discussion of proposed Rule 15b7-2, the Commission staff recognizes that "isolated systems problems…[such as] occasional delays or outages in electronic systems…or software glitches" would not violate the rule. However, there is nothing in the rule as drafted which reflects any materiality standard, or any concept of prevailing industry norms and standards. The proposed rule states only that a firm should assess its operational capability “taking into consideration the nature of [the firm’s] business.” It is not at all clear what that phrase means, or whether a firm would be able to rely on it in an enforcement proceeding that is based on the absolute standard that seems to be implicit in the rule. At the end of every business day, every broker-dealer is faced with transactions which have not been "promptly and accurately" completed, i.e. “fails to deliver” or “fails to receive,” discrepancies in comparisons with counter-parties, errors in confirmations, etc. The rule as drafted makes no allowance for the fact that on days when transaction volume regularly exceeds 700,000,000 shares, there will inevitably be "delays", "outages", "software glitches", or other problems resulting in errors and discrepancies. The language does not specify how the rule would differentiate occasional problems from those that are more chronic. Finally, before adopting such sweeping powers, the Commission should be required to show why existing operational capability rules –such as the NYSE and NASD rules cited by the Commission that set standards for specific operational processes – are not sufficient to address the perceived problem. If the existing rules have somehow proven inadequate, it would be helpful to know how and in what circumstances. We submit that if there is a need for a general rule of operational capability - - to apply at all times and in all circumstances - - the Commission should re-propose that rule separately, and allow a more reasonable timetable for comment than is provided by combining it with the Year 2000 operational readiness rule. 2. Proposed Rule 15b7-3T requires some technical changes to rule language to clarify when a firm is impacted by the rule. As a general matter, we believe the proposed elements that would give rise to a material Year 2000 problem or the presumption of a material Year 2000 problem are reasonably designed to isolate only the most serious problems. However, in order to reduce the likelihood of misinterpretation in (b)(1) and (b)(2), we believe the rule language needs to make clear that a material Y2K problem is one in which a “mission critical” system is experiencing a “material” problem arising from the misreading of dates. For example, under proposed rule (b)(1) any computer non-recognition of the Year 2000 which would impair any mission critical computer system to any degree constitutes a "material Year 2000 problem" - - whether or not the impairment would be material. Similarly, under subsection (b)(2), a broker-dealer is presumed to have a "material Year 2000 problem" if it does not have written procedures, has not undertaken remediation efforts and has not verified those efforts - - without any reference to a materiality standard. SIA believes that the supervisory procedures criteria in particular exalts form over substance since the key to Y2K readiness is whether a broker-dealer can operate its critical systems in the Year 2000. Finally, under clause (iv), the failure to remediate all exceptions in an accountants' report filed under Rule 17(a)-5(e)(5)(vi) would constitute a "material Year 2000 problem", whether or not the exception was material. For example, an exception in the accountants’ report for an unfinished contingency plan should not be deemed a material Year 2000 problem, because the lack of such a plan, while important for other reasons, would not hinder its ability to operate its critical systems in January of 2000. We submit that the rule should be revised so that a standard of materiality - - which has been explicitly recognized by the staff as the basis for Commission action - - is reflected in the detailed provisions of the rule. 3. The Division of Market Regulation should ensure that it has the proper authority to issue reprieves or exemptions from the rule on an expedited basis. Part (d) of proposed rule 15b7-3T should begin with an exemptive clause – i.e., “Unless the Commission by rule or by order decides differently...” – to clarify that the Division, and not just the Commission, has the authority to issue exemptions. Of course, language authorizing the delegation of this authority from the Commission to the Division should also be included. 4. Due to an apparent drafting error, the "certification" provision of proposed Rule 15b7-3T(e)(2) would only protect a broker-dealer from termination of its business through October 15, 1999. The proposed rule provides a "fail safe" provision which allows a broker-dealer that has a material Year 2000 problem to protect its business by filing a certificate signed by the chief executive officer. Under this provision, the chief executive officer is required to provide assurance that the broker- dealer is remedying the Year 2000 problem, will be testing it (no later than October 15, 1999), and that the problem will not impair the broker-dealer's operational capability. The Committees believe this is a reasonable approach, which would permit broker-dealers who have fallen behind in their remediation efforts to promptly bring themselves up to industry standard. However, the provision as drafted only provides relief to the complying broker-dealer until "the date specified in your certificate and in no event later than October 15, 1999". Read literally, that would require the broker-dealer to close down on October 15, 1999, even after advising the Commission that it has taken the steps needed to bring itself into Year 2000 operational capability. This would appear to be a drafting lapse. Presumably, it is - - or should be - - the intent of the rule to permit a broker-dealer that files the requisite certification to continue in business beyond October 15. With respect to the text of the proposed certificate set out in rule (e)(1), there appears to be another drafting lapse in the language of clause (iv). Clause (iv) requires the chief executive officer to certify that the material Year 2000 problem will [not] "impair your ability" … to insure operational capability. However, the reason the certificate is being filed at all is because a firm has previously given notice that there is a "material Year 2000 problem" that is likely to impair operational capability, a problem that the broker-dealer is presumably in the process of addressing. If a broker-dealer can make the representation required in clause (iv) in the certification, it probably could have avoided filing the initial notice. It appears more reasonable to have clause (iv) of the certification focus on a pledge to repair the previously disclosed problem fixed, rather than an outright denial of it. To this end we recommend that the certification language in clause (iv) require the chief executive officer to certify that: "Based on inquiries and to the best of the chief executive officer's knowledge, you anticipate that the steps referred to in clauses (i) through (iii) above will result in remedying the material Year 2000 problem on or before the date set forth above, but in no event later than October 15, 1999." 5. Other Comments. SIA believes that the rules should specify an orderly procedure and an appropriate time frame for the transfer of assets by a firm with material Year 2000 problems and no possibility of remedy. The rule merely indicates that an affected firm may no longer perform specific functions, but does not specify the steps that should be undertaken in order to achieve an orderly shut-down. The SIA would oppose a third party verification requirement in the case of a firm that certifies it is remediating a disclosed material Year 2000 problem.” Such verification would be very expensive and difficult to obtain on short notice, and would drain resources away from the more urgent task of remediation. The independent public accountant’s report that is to be submitted with the second BD-Y2K report will already have sufficient information regarding remediation efforts to enable the SEC to follow up with any affected firm. The SIA believes that regardless of how the rule ultimately apportions the responsibilities of clearing firms and introducing firms, the Commission should recognize the difficulty a clearing firm will have in responding in a timely and efficient manner to each request made by an introducing firm for a confirmation of operability. There are in fact limits to the amount of staff and other resources that can be devoted to such requests when clearing firms are already being asked to furnish considerable documentation in connection with individual testing pursuant to NASD, NYSE, and SEC rules. If the Commission determines that the additional confirmation is still necessary and it will not detract from ongoing Y2K efforts, then it should provide some interpretive guidance regarding the required elements of a confirmation and clarify the extent to which uniform responses may be used. Finally, while the discussion section of the rule filing refers to the rule as temporary, there is no “sunset” provision included in the rule language itself indicating when the rule will expire. 6. Conclusion. The SIA thanks you for the opportunity to provide comments on the rule proposal. We appreciate the opportunity to work with you to assure broker-dealer readiness for the challenge of Year 2000 operational capability and would welcome the opportunity for similar cooperative efforts to address operational capability outside of the Year 2000 context. If we can provide any further information or clarification of points made in this letter, please contact the undersigned, or Scott Kursman, SIA Assistant General Counsel, at 212-618-0508. Respectfully submitted, Lee B. Spencer, Jr. Charles Vadala Chairman Chairman Federal Regulation Committee Capital Committee Michael L. Michael Oliver J. Herzfeld Chairman Chairman Technology & Regulation Committee Year 2000 Legal & Regulatory Committee Jerome J. Clair Chairman Operations Committee CC: The Honorable Arthur Levitt, Chairman The Honorable Norman S. Johnson, Commissioner The Honorable Isaac C. Hunt, Jr., Commissioner The Honorable Paul A. Carey, Commissioner The Honorable Laura S. Unger, Commissioner Annette Nazareth, Director, Division of Market Regulation Robert L. Colby, Deputy Director, Division of Market Regulation Belinda Blaine, Associate Director, Division of Market Regulation