[Federal Register: February 20, 1997 (Volume 62, Number 34)]
[Rules and Regulations]
[Page 7675-7678]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
Alternative Method of Compliance With the Written Record
Requirements
AGENCY: Commodity Futures Trading Commission.
ACTION: Advisory; alternative method of compliance.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
issuing advice concerning compliance with the ``written'' record
requirements of Commission Regulation 1.35 (17 CFR 1.35) for customer
orders which are prepared and transmitted to and reported from exchange
trading pits by electronic order-routing systems and for customer
orders prepared by electronic off-floor order management systems
(referred to collectively as ``electronic order-routing systems''). The
``written'' record requirements of Commission Regulation 1.35(a-1)(1),
(a-1)(2)(i), (a-1)(4), and/or (d) will be deemed satisfied, subject to
the terms and conditions set forth in this Advisory, to the extent that
such a system generates electronic rather than ``written'' records. The
electronic record of a customer order generated through an electronic
order-routing system must include any modification made to the order,
including any change or correction, as well as the time the
modification is recorded in the system. The system also must maintain
an accurate record of when and by whom records are accessed or
modified. In addition, such a system must capture all order-related
times required under these Commission Regulation 1.35 subsections to
the highest level of precision achievable by the operating system. In
this regard, such a captured time must be accurate at least to the
second. The time captured must not use a clock that can be modified by
the person entering the order. All electronic records of customer
orders created by an electronic order-routing system must be maintained
in accordance with the record retention requirements of Commission
Regulation 1.31.
FOR FURTHER INFORMATION CONTACT: Kimberly A. Browning, Attorney/
Advisor, Division of Trading and Markets, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington,
D.C. 20581. Telephone: (202) 418-5490.
SUPPLEMENTARY INFORMATION:
I. Introduction
The Commission is hereby issuing guidance concerning alternative
compliance with the ``written'' record requirements of certain
Commission Regulation 1.35 subsections which call for the preparation
of ``written'' records of customer orders. Specifically, Regulation
1.35(a-1)(1) requires that a futures commission merchant (``FCM'') and
introducing broker (``IB''), immediately upon receiving a customer's or
option customer's order, prepare a written record of such order,
including the account identification, order number, and a timestamp
indicating the date and time, to the nearest minute, the order is
received.<SUP>1 Similarly, Regulation 1.35(a-1)(2)(i) provides that
each member of a contract market who receives a customer order on an
exchange floor that is not in the form of a written record immediately
upon receipt of such order prepare and timestamp a written record of
the order.<SUP>2 For all such orders, Regulation 1.35(a-1)(4) requires
an exit timestamp indicating the date and time of the report of
execution.<SUP>3 Regulation 1.35(d) provides that a contract market
member who executes a trade must prepare a trading card or other record
showing the fill information for the customer purchase or sale
order.<SUP>4
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\1\ Commission Regulation 1.35(a-1)(1) states that:
Each futures commission merchant and each introducing broker
receiving a customer's or option customer's order shall immediately
upon receipt thereof prepare a written record of such order,
including the account identification and order number, and shall
record thereon, by time-stamp or other timing device, the date and
time to the nearest minute, the order is received, and in addition,
for [an] option customer's order, the time, to the nearest minute,
the order is transmitted for execution.
\2\ Commission Regulation 1.35(a-1)(2)(i) states that:
Each member of a contract market who on the floor of such
contract market receives a customer's or option customer's order
which in not in the form of a written record including the account
identification, order number, and the date and time, to the nearest
minute, such order was transmitted or received on the floor of such
contract market, shall immediately upon receipt thereof prepare a
written record of such order in non-erasable ink, including the
account identification and order number and shall record thereon, by
time-stamp or other timing device, the date and time, to the nearest
minute, the order is received.
\3\ Commission Regulation 1.35(a-1)(4) states that:
Each member of a contract market reporting the execution from
the floor of the contract market of a customer's or option
customer's order or the order of another member of such contract
market received in accordance with paragraphs (a-1)(2)(i) * * * of
this section, shall record on a written record of such order,
including the account identification and order number, by time-stamp
or other timing device, the date and time to the nearest minute such
report of execution is made. Each member of a contract market shall
submit the written records of customer orders or orders from other
contract market members to contract market personnel or to the
clearing member responsible for the collection of orders prepared
pursuant to this paragraph as required by contract market rules
adopted in accordance with paragraph (j)(1) of this section. The
execution price and other information reported on such order tickets
must be written in non-erasable ink.
\4\ Commission Regulation 1.35(d) states, among other things,
that:
Each member of a contract market who, in the place provided by
the contract market for the meeting of persons similarly engaged,
executes purchases or sales of any commodity for future delivery or
commodity option on or subject to the rules of such contract market,
shall prepare regularly and promptly a trading card or other record
showing such purchases and sales. Such trading card or record shall
show the member's name, name of the clearing member, transaction
date, time, quantity, and, as applicable, underlying commodity,
contract for future delivery or physical, price or premium, delivery
month or expiration date, whether the transaction involved a put or
a call and strike price. Such trading cards or other record shall
also clearly identify the opposite floor broker or floor trader with
whom the transaction was executed, and the opposite clearing member.
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The Commission is issuing this Advisory to facilitate further the
implementation and use of electronic order-routing systems, including
both proprietary and exchange systems, in U.S. futures markets. This
action constitutes the latest in a series of steps taken by the
Commission to encourage the futures industry to realize the business
and regulatory benefits of such systems. Recently, to advance the
public dialogue on improving the efficiency of exchange and proprietary
order-routing systems and to discuss potential practicability issues
related to audit trail standards,<SUP>5 the Commission convened a
public Roundtable in Chicago, Illinois on October 16, 1996. At that
forum, market users, financial market experts,
[[Page 7676]]
exchange officials and academics met to discuss the trade automation
issues currently before the futures industry. Discussion at the
Roundtable demonstrated the significance of the development and
implementation of exchange and proprietary electronic order-routing
systems to the continuing competitiveness of the U.S. exchanges and
their member firms.<SUP>6 Previously, in February and March 1996, the
Commission received automation briefings by the Chicago Mercantile
Exchange (``CME''), New York Mercantile Exchange, Coffee, Sugar & Cocoa
Exchange, Inc., Chicago Board of Trade, and the Futures Industry
Association. The Commission issued a public summary of these
proceedings on May 10, 1996, entitled the ``Market Automation
Briefings-Commission Summary.''
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\5\ Section 5a(b)(3) of the Futures Trading Practices Act of
1992 (``FTPA'') sets forth various heightened audit trail
requirements which are subject to a ``practicability'' standard.
\6\ The Commission shortly will be issuing a public summary of
the Roundtable proceedings.
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The Commission has recognized the important business benefits that
can result from electronic order routing systems.<SUP>7 The Commission
also has emphasized that the FTPA ``does not mandate that its enhanced
audit trail requirements be met through electronic means.'' <SUP>8
Nevertheless, the Commission believes that ``the effective use of
technology [will ultimately] * * * provide safer, more efficient, well-
supervised markets.'' <SUP>9
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\7\ See the Commission's ``Report on Audit Trail Status and Re-
Test'' dated August 12, 1996 at p. 42.
\8\ See the Commission's November 1994 ``Report to Congress on
Futures Exchange Audit Trails'' at p. 62.
\9\ See the Commission's May 10, 1996 ``Market Automation
Briefings-Commission Summary'' at p. 3.
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II. Staff No-Action Positions Previously Taken Regarding Electronic
Order-Routing Systems
To date, the Commission's Division of Trading and Markets
(``Division''), in consultation with the Commission's Office of
Information Resources Management (``OIRM''), has issued four no-action
letters relating to electronic order-routing systems. Each of the no-
action letters provided that the use of a specified electronic order-
routing system was not inconsistent with the ``written'' record
preparation requirements of Commission Regulation 1.35. Two letters
addressed systems which involved transmission of orders to and from a
trading pit. One of those letters dealt with a firm proprietary system
<SUP>10 and the other an exchange system.<SUP>11 The two other letters
involved firm proprietary electronic off-floor order management
systems.<SUP>12 Essentially, those systems provide for the electronic
generation, modification, and maintenance of a firm's ``office''
orders, that is, both discretionary and non-discretionary orders
required to be prepared pursuant to Commission Regulation 1.35(a-1)(1).
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\10\ On July 8, 1996, the Division issued a letter to CME that
permitted the CME to allow one of its clearing member firms, Timber
Hill, LLC (``Timber Hill'') to use, on a permanent basis, a handheld
trading device and system (``Timber Hill System'') to receive
customer orders in and report executions from the equity quadrant of
the CME, described infra. By letter dated August 25, 1995, the
Division originally permitted the CME to use the Timber Hill System
for a 90-day pilot program. Extensions of that pilot program were
subsequently granted by the Division.
\11\ On June 14, 1996, the Division issued a letter that allowed
a six-month pilot program to be implemented at CME under which
certain CME member firms and floor broker groups are allowed to
route customer orders for the front month of the CME's Eurodollar
futures contract through the CME's electronic order-routing system,
the ``Trade Order Processing System'' (``TOPS''), to the CME's order
receipt system, the ``Universal Broker Station'' (``CUBS'') (``TOPS-
CUBS Program''), described infra. By letter dated December 13, 1996,
Division staff permitted CME to extend the TOPS-CUBS Program to June
13, 1997.
\12\ On July 21, 1994, the Division issued a letter to Goldman,
Sachs & Co. (``Goldman Sachs'') permitting it to implement its
automated order preparation and record keeping system, Automated
Order Routing and Trade Accounting (``AORTA''). The AORTA system is
described infra.
On September 12, 1996, the Division issued a similar letter to
Morgan Stanley & Co. (``Morgan Stanley'') permitting it to implement
its automated Order Management System (``OMS''), described infra.
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In assessing both the Timber Hill System <SUP>13 and the TOPS-CUBS
Program,<SUP>14 Division and OIRM staff found both systems are used to
generate, in electronic form, all of the customer order information
required by Commission Regulation 1.35. In this regard, both the Timber
Hill System and the TOPS-CUBS Program capture all modifications made to
a customer order, including changes and/or cancellations, as well as
the times of such modifications to the nearest second. Moreover, in
those cases where an order is filled partially, both the Timber Hill
System and the TOPS-CUBS Program reflect the actual quantity that has
been executed and timestamp the report of the partial execution to the
nearest second. Commission staff also found that both the Timber Hill
System and the TOPS-CUBS Program record the necessary Regulation 1.35
times for receipt of customer orders and report of execution times from
the trading pit and do so more precisely than is required under the one
minute standard in Regulation 1.35.
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\13\ In summary, under the Timber Hill System, a customer enters
his order(s) electronically through a customer workstation(s)
located on his premises. That order then is transmitted via the
Timber Hill Network to a basestation located on the CME trading
floor in a booth in proximity to the CME's Standard & Poors 500 and
NASDAQ 100 futures and options pits. Upon receipt of the order by
the floor basestation, the basestation broadcasts it to a wireless
handheld device held by a Timber Hill floor broker located in the
trading pit for execution. Upon execution (partial or complete), the
order's fill information, as input into the handheld device by the
floor broker, is transmitted from the handheld unit back to the
basestation. The basestation then transmits the fill confirmation
information back to the customer at his workstation via the Timber
Hill System.
\14\ In summary, TOPS is an electronic order entry, routing and
fill reporting system. Under the TOPS-CUBS Program, orders for the
Eurodollar futures contract are transmitted through TOPS, which
includes terminals located off the trading floor, to CUBS computer
terminals and associated software designed for use by a broker and/
or a broker's clerk while at or in the trading pit. The CUBS system
is a wired broker workstation that sits on a pedestal in the pit. It
receives orders routed by TOPS and performs electronic order deck
management.
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With respect to the storage of customer order data, both the Timber
Hill System <SUP>15 and the TOPS-CUBS Program <SUP>16 maintain
Commission Regulation 1.35 order information <SUP>17 for the
statutorily required five-year time period, as provided under
Regulation 1.31.<SUP>18 The staff found that both systems
[[Page 7677]]
were not inconsistent with that regulation, which permits data
generated in electronic form to be maintained in optical media and in
other forms. In addition, all Regulation 1.35 order information stored
in connection with the Timber Hill System and the TOPS-CUBS Program, as
described above, is made available, in a timely manner, for access by
the Commission upon request in hard copy or machine readable form.
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\15\ The Timber Hill System basestation maintains an on-line
file of all customer orders transmitted through it, including order-
related timestamps. CME receives this file from the basestation via
a serial port feed (cable) on a real-time basis. Upon receipt of the
basestation data, CME maintains it in machine-readable form and will
keep it for the required five-year time period as provided under
Commission Regulation 1.31, described infra.
Timber Hill also provides data for all customer orders executed
through the Timber Hill system to the CME's clearing system via the
on-line system which all CME member firms use to submit trade data
to the CME's clearing system, the TREX Record. In addition, customer
trade data are stored on the hard drives of customer workstations.
On a daily basis, Timber Hill backs up to magnetic tape all customer
trade data generated through the basestation, the main/''host''
computer and the customer workstations. Within one week of being
generated, such data are placed on an optical disc(s). Twice a
month, duplicate optical disks are deposited in a vault located off-
site.
\16\ Customer order data generated by trading activity occurring
under the TOPS-CUBS Program are stored in two separate databases, a
TOPS database and a CUBS database. This storage is conducted in
accordance with the CME's routine security and disaster prevention
procedures. As a preliminary matter, data in both databases is
``backed-up'' every evening onto a series of disk drives on the
CME's mainframe computer, where it is stored for 30 days.
Subsequently, CME stores the data from both databases in its
archives on cartridge tape in a secure location.
\17\ Commission Regulation 1.35(a) requires, among other things
that each FCM, IB and member of a contract market must ``keep full,
complete, and systematic records, together with all pertinent data
and memoranda, of all transactions relating to its business dealing
in commodity futures, commodity options, and cash commodities.''
Regulation 1.35(a) further provides that such records, which include
all orders (filled, unfilled, or cancelled) and trading cards are to
be maintained in accordance with the requirements of Regulation
1.31.
\18\ Commission Regulation 1.31 requires, among other things,
that:
All books and records required to be kept by the [Commodity
Exchange] Act or [Commission] regulations shall be kept for a period
of five years from the date thereof and shall be readily accessible
during the first [two] years of the [five] year period. All such
books and records shall be open to inspection by any representative
of the Commission or the U.S. Department of Justice [(''DOJ'')].
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With respect to the TOPS-CUBS Program, Commission staff noted that
the Program's ability to record electronically and automatically
required Regulation 1.35 customer order information, including order-
related times, enhances the preparation of customer data in terms of
accuracy and detection of changes and should provide regulatory
benefits.<SUP>19 The Timber Hill System provides similar benefits.
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\19\ See the Division's June 14, 1996 letter to Stephen Szarmack
of the CME regarding the CME's request for no-action relief for the
six-month pilot TOPS-CUBS Program at p. 13.
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As previously noted, the two other staff no-action letters relate
to electronic office order management systems. Those systems involve
the electronic generation, maintenance and retention of office orders
related to exchange trading. In general, the systems are intended to
increase the efficiency with which these firms manage their order
books, including through increased integration with other firm and
customer activities. To date, both the Goldman Sachs AORTA system and
the Morgan Stanley OMS system do not involve electronic transmission of
orders to and from the exchange floor.<SUP>20 Nonetheless, these
systems involve issues similar to those relating to the Timber Hill
System and the TOPS-CUBS Program, but within the confines of their more
limited operational scope.
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\20\ For reasons unrelated to applicable regulatory
requirements, the implementation of both of these systems has been
delayed.
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In assessing the AORTA and OMS systems, Division and OIRM staff
found that both systems record, in electronic form, all of the customer
order information required by Commission Regulation 1.35 for office
orders.<SUP>21 In addition, both systems were found to capture the time
of order entry, the time of the transmission of a customer order to the
floor, and the time that a sales person enters order fill (partial or
complete) information into his system.<SUP>22 Both AORTA and OMS record
any change to the customer order information, including the identity of
the sales person making any change and the time of such change.
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\21\ In summary, the AORTA and OMS systems operate as follows:
sales personnel prepare a computerized office order ``ticket,''
instead of a paper ticket, immediately upon receipt of a customer
order and enter all of the customer order information currently
required under Regulation 1.35. Both systems record, automatically,
the precise time to the nearest second at which an order was
entered. Upon order entry, sales personnel then send orders to the
floors by telephone and indicate by keystroke that the order has
been transmitted. Both systems automatically record a second time
indicating when the order was transmitted to the floor. Fill
information, including the report of execution time, is transmitted
back from the floor to sales personnel, who enter that information
into their system.
\22\ This exceeds the requirements of Commission Regulation
1.35(a)(a-1)(i), which calls for the time a customer order was
received and, for options, also the time the order is transmitted
for execution.
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With respect to data storage, both AORTA and OMS were found to
satisfy the record retention requirements of Commission Regulation
1.31.<SUP>23 Moreover, both of those systems were found to provide
regulatory benefits in that they enhance the standards for office order
preparation as provided under Commission regulation 1.35.
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\23\ AORTA stores all records of customer orders on optical
disk. Records produced and retained by AORTA are available for
production to the Commission or the DOJ in hard copy, on diskette,
or on CD-ROM.
All records of customer orders generated on OMS are stored on
Morgan Stanley's Sybase Relational Database Management System
(``Sybase''). Morgan Stanley supplements storage of data on Sybase
with a hard copy/microfiche regime under which all transaction-
related information is reproduced from Sybase on a daily basis and
kept either in hard copy or microfiche for five years.
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III. Discussion
The Commission believes that it is appropriate to take into account
and to facilitate automation developments that are occurring with
respect to exchange-related trading. The Commission also believes that
it is preferable to do so through the issuance of this Advisory rather
than through the case-by case approach taken by staff in response to
the aforementioned proposals for electronic order-routing systems. This
Advisory will enable new order routing systems to come on line without
the necessity of first seeking a no-action position regarding the
``written'' record requirements of Commission Regulation 1.35. As a
result, the important business and regulatory benefits these systems
can provide will be fostered.
For an electronic order-routing system to be covered by this
Advisory, it must satisfy the standards discussed below.<SUP>24 Those
standards are consistent with the terms of the staff no-action
positions previously taken regarding such systems and take cognizance
of such systems' enhanced operational capabilities.
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\24\ If an order-routing system did not satisfy any of the
standards set forth herein, then the operator of the system would
still be able to request an individual no-action position as
appropriate.
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To the extent that an electronic order-routing system captures
information required under Commission Regulation 1.35(a-1)(1), (2)(i),
(4), and/or (d), and provided such system satisfies the standards set
forth below, a ``written'' record need not be prepared. To the extent
that a system is intended to satisfy one or more of those provisions,
then the system must include all information that otherwise would be
required to be in written form. Moreover, insofar as a system is used
to comply with any one or more of the foregoing sections, it must
include all information required by that section(s).<SUP>25
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\25\ In particular, the Commission notes that it is critical for
such systems to satisfy the account identification requirements of
Regulation 1.35.
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The electronic record of a customer order generated by an
electronic order-routing system must include any and all modifications
made thereto. The record must include any changes and/or cancellations.
All order-related times required under Commission Regulation 1.35, as
well as the times for all modifications, are to be captured to the
highest level of precision achievable by the operating system. In this
regard, the Commission's experience is that these systems have the
capability, at a minimum, to capture times to the second. Therefore,
the Commission is requiring that such times must be accurate at least
to the second. In addition, the times captured must not use a clock
that can be modified by the person entering the order.
These systems also need to conform to the Commission's record
keeping requirements as provided in Commission Regulation 1.31 for
computer-generated records. Pursuant to that rule, computer-generated
records can be substituted for a hard copy report when produced and
maintained on optical disk in conformity with 1.31(d), microfilm, or
microfiche. A computer-generated record used in lieu of a hard copy
must be transferred to one of these three permitted non-erasable media
``as soon as is feasible.'' <SUP>26 In addition, ``appropriate
safeguards'' must be in place to protect any such records temporarily
stored in erasable form so as
[[Page 7678]]
to prohibit unauthorized access to the records and to provide for a
record of the identity of the persons who access such records and of
any modifications made.<SUP>27 In addition, assurance must be provided
that a computer-generated record will be made readily available in
machine-readable media or hard copy to the Commission or DOJ upon
request. Moreover, records stored on ``machine readable media must use
a format and coding structure'' specified in such a request by the
Commission or DOJ.<SUP>28
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\26\ See the Commission's Regulation 1.31 final rulemaking,
which allows production of computer-generated records on optical
disk to be immediately substituted for hard copy reports for
purposes of record storage. 58 FR 27458 (May 10, 1993) at 27460. The
Commission also notes that it may be necessary to amend Regulation
1.31 to account for further technological developments.
\27\ Id.
\28\ Id. at 27465.
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The Commission recognizes that the development of electronic order-
routing systems continues to be in flux. The Commission intends to
continue to monitor that process with a view toward providing further
guidance by advisory or rule in the future. Among other things, the
Commission will evaluate the manner in which electronic order-routing
systems may interface with other audit trail recordkeeping practices in
place at an exchange.
IV. Conclusion
To the extent that a customer order is prepared and transmitted to
and reported from an exchange trading pit by an electronic order-
routing system, or a customer order is prepared by an electronic off-
floor order management system, and the standards set forth below are
satisfied, then the ``written'' record requirements of Commission
Regulation 1.35(a-1)(1), (a-1)(2)(i), (a-1)(4), and/or (d) will be
deemed satisfied by the electronic record generated by the system.
Specifically, such electronic records must:
(1) Include the customer order information required under
Commission Regulation 1.35.(a-1)(1), (2)(i), (a-1)(4) and/or 1.35(d);
(2) Include any modification, including any change and/or
cancellation, that is made to an order and indicate the time the
modification is recorded in the system;
(3) Record all Commission-required and other order-related times,
including order entry and exit times, and the time of any modification
made to a customer order, including any change and/or cancellation, to
the highest level of precision achievable by the operating system, but
at least to the second. The times captured must not use a clock that
can be modified by the person entering the order;
(4) Be kept in hard copy and/or allowable hard copy substitution
media, as provided under Commission Regulation 1.31. The stored records
shall be open to inspection by the Commission or DOJ as required under
Commission Regulation 1.31 and be made readily available to the
Commission or DOJ in machine-readable media or hard copy upon request.
Records stored on machine-readable media must use a format and coding
structure specified in the Commission request. To the extent that
records temporarily are stored in erasable form, appropriate security
measures must be implemented by the system operator to prohibit any
unauthorized access to the records and to maintain an accurate record
of when and by whom records are accessed or modified.
Issued in Washington, DC on February 12, 1997.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 97-4004 Filed 2-19-97; 8:45 am]
BILLING CODE 6351-01-P
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