Interpretive Letter to Steven F. Gatti, Esq., Clifford, Chance, Rogers & Wells
June 15, 2000
Steven F. Gatti, Esq.
Clifford, Chance, Rogers & Wells
607 Fourteenth Street NW
Washington DC, 20005-2018
Re: Electronic Batch Approval of New Customer Accounts
Dear Mr. Gatti:
I am responding to your letter of February 24, 2000 to NASD Regulation, Inc., ("NASD Regulation") and our subsequent conversations wherein you ask whether the use by E*Trade Securities, Inc. ("E*TRADE") of information technology in connection with reviewing and approving new customer accounts is in accordance with the provisions of NASD Rules 3110(c) and 3010(d).
Your letter describes the facts as follows. E*TRADE seeks to institute a software program, the "batch process," and adopt related policies and procedures that will facilitate the review and approval process of multiple customer account applications by registered E*TRADE principals. The purpose of the batch process is to achieve efficiencies and greater consistency in the new account review and approval process by allowing designated E*TRADE registered principals to review multiple account applications that meet pre-set criteria for approval.
E*TRADE has established consistent guidelines for approving new accounts that are currently used by registered principals in reviewing customer applications on an application by application basis. As part of the batch process, E*TRADE intends to code the criteria electronically and to sort applications electronically based on the pre-set criteria. Under the proposal, when a new account application and accompanying documentation is received, E*TRADE will image all of the documents on optical disks and store the documents as an electronic package. Thereafter, E*TRADE will filter and/or sort data from a database of account information, which will likely be its Single Point of Entry database ("SPOE"), through a pre-established criteria-based system. The account information database will include all information relevant to the account approval process, including but not limited to customer name and address, date of birth, social security number, residency/citizenship, signature, occupation and other information disclosed on the account application. E*TRADE will pre-screen the SPOE for irregularities, such as bogus addresses, compliance with Office of Foreign Assets Control regulations, jurisdictional considerations and other non-discretionary matters. Principals with authority to make account application determinations will not be involved in the process of imaging documents on optical disks.
After the customer account information is stored electronically, authorized E*TRADE principals will be able to access applications in groups, categorized based on the criteria established by E*TRADE’s Credit Committee. The pre-established criteria will encompass all relevant issues that currently guide principals with respect to the individual manual account review process. Minimum account approval criteria will be established by the Credit Committee with respect to each type of account currently offered by E*TRADE.
E*TRADE currently has seven different levels of approval for accounts: (1) cash only; (2) cash/margin; (3) cash/level one options; (4) cash/level two options; (5) margin/level one options; (6) margin/level two options; and (7) margin/level three options. Although the principal has discretion to set standards that are more restrictive than the pre-established criteria established by the Credit Committee for the account type in question, the principal may not override the pre-established criteria. The Credit Committee is composed, in part, of principals of the firm.
At all times, the registered principal will have the ability to review and inspect individual applications from each batch. The registered principal may, based on further inspection, reject an application that, based on the pre-established criteria, would otherwise be approved. Such applications will be considered "exceptions" and will be subject to further review by a different principal pursuant to the firm’s written exception resolution procedures. Principals will not be authorized to exercise discretion with respect to applications that do not meet the minimum established criteria for a particular level.
E*TRADE’s procedures will include provisions mandating that all principals with authority to review and approve batches of new accounts have only appropriate discretion in making exceptions. After reviewing the approved batch of applications, the principal may accept the batch on an aggregate basis.
E*TRADE will store all electronic account application information on a form of write once, read many ("WORM") technology to maintain records consistent with the requirements of NASD Rule 3110 and Securities and Exchange Commission ("SEC") Rules 17a-3 and 17a-4. For approved account applications, the initials of the approving E*TRADE principal will be stored in WORM format with the application. To facilitate internal and external audits, E*TRADE will maintain a master log noting for each account, the specific approval batch, the date of approval, and the principal who approved each account.
The E*TRADE batch approval technology will allow NASD examining staff immediate access to required books and records. The batch process software will also permit the examining staff to download and print hard copies of the required books and records, and will be organized and indexed in a manner that will allow for limited cross-referencing. Thus, the system will allow examiners to review copies of all relevant imaged documents and an audit trail of principals who reviewed the customer new account package through the approval process.
Moreover, the batch process software and the firm’s policies and procedures will provide for adequate security and restrictions on access to authorized employees and principals only. E*TRADE will employ a company-wide general security system and will define which individuals will have access and what functions each individual will be authorized to undertake through the system. The batch process will be accessible only by authorized principals and access will be controlled through password security. Passwords will be changed periodically and are safeguarded against unauthorized use.
In addition, E*TRADE will maintain written policies and procedures that accurately describe the batch process, its safeguards, and its operating procedures to ensure compliance with NASD rules. E*TRADE plans to conduct periodic reviews, at least quarterly, of the policies, procedures, and operations to ensure that the system operates as designed and documented and in accordance with the requirements of NASD and SEC rules.
You have asked that the NASD confirm that the use of information technology in connection with reviewing and approving new customer accounts by a principal through the use of the batch process is in accordance with the provisions of Rules 3110(c) and 3010(d).
NASD Rule 3110(c)(1)(C) requires members to maintain, for each customer account opened after January 1, 1991, a signature of the registered representative introducing the account and signature of the member or partner, officer, or manager who accepts the account. NASD Rule 3010(d) requires that each member establish procedures for the review and endorsement by a registered principal in writing, on an internal record, of all transactions and all correspondence of its registered representatives pertaining to the solicitation or execution of any securities transaction.
Although the NASD rules do not expressly provide for electronic batch approval, the staff believes that the use of the batch process to satisfy the principal approval requirement under NASD Rule 3110(c)(1)(C) is permissible so long as E*TRADE complies with the following safeguards and conditions:
- E*TRADE will store all electronic account application information on technology consistent with NASD Rule 3110 and SEC Rules 17a-3 and 17a-4;
- the batch process permits NASD examining staff immediate access to required books and records;
- the batch process permits the examining staff to download and print hard copies of required books and records;
- the batch process allows examiners to review copies of all relevant imaged documents and provides an audit trail of principals who reviewed the customer new account package through the approval process;
- the batch process software and E*TRADE’s policies and procedures provide for a company-wide general security system and define which individuals will have access and what functions each individual will be authorized to undertake through the system; and
- the batch process is accessible only by authorized principals wherein access will be controlled through password security, and the password will be changed periodically and safeguarded against unauthorized use.
The conclusion above is limited to the ability of E*TRADE to use software automatically to sort new account information to permit principal review and approval, and related data storage, access, and security procedures, and is not intended to address the appropriateness of: (1) the specific account categories, (2) the minimum account approval criteria for each category, (3) the standards used to determine the criteria, or (4) the effectiveness of the review and approval process.
This letter responds only to the issues you have raised based on the facts as you have described them in your letter and our recent conversations, and does not address any other rule or interpretation of the NASD or all the possible regulatory and legal issues involved. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASD Regulation, Inc.
Robert J. Smith
Assistant General Counsel