Broker-Dealer Reports, 51909-52003 [2013-18738]
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Vol. 78
Wednesday,
No. 162
August 21, 2013
Part III
Securities and Exchange Commission
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17 CFR Parts 240 and 249
Broker-Dealer Reports; Final Rule
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Parts 240 and 249
[Release No. 34–70073; File No. S7–23–11]
RIN 3235–AK56
Broker-Dealer Reports
Securities and Exchange
Commission.
ACTION: Final rule.
AGENCY:
The Securities and Exchange
Commission (‘‘Commission’’), under the
Securities Exchange Act of 1934
(‘‘Exchange Act’’), is amending certain
broker-dealer annual reporting, audit,
and notification requirements. The
amendments include a requirement that
broker-dealer audits be conducted in
accordance with standards of the Public
Company Accounting Oversight Board
(‘‘PCAOB’’) in light of explicit oversight
authority provided to the PCAOB by the
Dodd-Frank Wall Street Reform and
Consumer Protection Act (‘‘Dodd-Frank
Act’’) to oversee these audits. The
amendments further require a brokerdealer that clears transactions or carries
customer accounts to agree to allow
representatives of the Commission or
the broker-dealer’s designated
examining authority (‘‘DEA’’) to review
the documentation associated with
certain reports of the broker-dealer’s
independent public accountant and to
allow the accountant to discuss the
findings relating to the reports of the
accountant with those representatives
when requested in connection with a
regulatory examination of the brokerdealer. Finally, the amendments require
a broker-dealer to file a new form with
its DEA that elicits information about
the broker-dealer’s practices with
respect to the custody of securities and
funds of customers and non-customers.
DATES: This rule is effective June 1,
2014, except the amendment to
§ 240.17a–5(e)(5), which is effective
October 21, 2013 and the amendments
to § 240.17a–5(a) and (d)(6) and
§ 249.639, which are effective December
31, 2013.
FOR FURTHER INFORMATION CONTACT:
Michael A. Macchiaroli, Associate
Director, at (202) 551–5525; Thomas K.
McGowan, Deputy Associate Director, at
(202) 551–5521; Randall W. Roy,
Assistant Director, at (202) 551–5522;
Mark M. Attar, Branch Chief, at (202)
551–5889; Rose Russo Wells, Special
Counsel, at (202) 551–5527; Sheila
Dombal Swartz, Special Counsel, at
(202) 551–5545; or Kimberly N.
Chehardy, Attorney, at (202) 551–5791,
Office of Financial Responsibility,
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SUMMARY:
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Division of Trading and Markets; or
Kevin Stout, Senior Associate Chief
Accountant, at (202) 551–5930, Office of
the Chief Accountant, Securities and
Exchange Commission, 100 F Street NE.,
Washington, DC 20549–7010.
SUPPLEMENTARY INFORMATION: The
Commission is adopting amendments to
Rule 17a–5 (17 CFR 240.17a–5) and
technical and conforming amendments
to Rule 17a–11 (17 CFR 240.17a–11) and
is adopting Form Custody (17 CFR 249.
639) under the Exchange Act.
Contents
I. Background
A. Overview
B. Rules Governing Broker-Dealer
Financial and Custodial Responsibility
1. The Broker-Dealer Net Capital Rule
2. The Broker-Dealer Customer Protection
Rule
3. The Broker-Dealer Quarterly Securities
Count Rule
4. The Broker-Dealer Account Statement
Rules
II. Final Amendments to Broker-Dealer
Reporting, Audit, Notification, and Other
Requirements
A. Overview of New Requirements
B. Annual Reports To Be Filed—Paragraph
(d) of Rule 17a–5
1. Requirement To File Reports—Paragraph
(d)(1) of Rule 17a–5
i. Proposed Amendments
ii. Comments Received
iii. The Final Rule
2. The Financial Report—Paragraph (d)(2)
of Rule 17a–5
3. The Compliance Report—Paragraph
(d)(3) of Rule 17a–5
i. The Proposed Amendments
ii. Comments Received
iii. The Final Rule
4. The Exemption Report—Paragraph (d)(4)
of Rule 17a–5
i. Proposed Amendments
ii. Comments Received
iii. The Final Rule
5. Time for Filing Annual Reports—
Paragraph (d)(5) of Rule 17a–5
6. Filing of Annual Reports with SIPC—
Paragraph (d)(6) of Rule 17a–5
i. The Proposed Amendments
ii. Comments Received
iii. The Final Rule
C. The Nature and Form of the Annual
Reports
1. Exemptions From Audit Requirement—
Paragraph (e)(1) of Rule 17a–5
2. Affirmation—Paragraph (e)(2) of Rule
17a–5
3. Confidentiality of Annual Reports—
Paragraph (e)(3) of Rule 17a–5
4. Supplemental Report on SIPC
Membership—Paragraph (e)(4) of Rule
17a–5
D. Engagement of the Accountant
1. Statutory Requirements and Commission
Authority
2. Engagement of Accountant
Requirements Prior to Today’s
Amendments
3. Amended Engagement of Accountant
Requirements
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i. Proposed Amendments
ii. Comments
iii. The Final Rule
E. PCAOB Registration of Independent
Public Accountant—Paragraph (f)(1) of
Rule 17a–5
F. Notification of Non-Compliance or
Material Weakness
1. New Notification Requirements—
Paragraph (h) of Rule 17a–5
i. The Proposed Amendments
ii. Comments Received
iii. The Final Rule
2. Conforming and Technical Amendments
to Rule 17a–11
G. Other Amendments to Rule 17a–5
1. Information Provided to Customers—
Paragraph (c) of Rule 17a–5
i. Background
ii. Availability of Independent Public
Accountant’s Comments on Material
Inadequacies—Paragraph (c)(2) of Rule
17a–5
iii. Exemption From Mailing Financial
Information to Customers—Paragraph
(c)(5) of Rule 17a–5
2. Technical Amendments
i. Deletion of Paragraph (b)(6) of Rule 17a–
5
ii. Deletion of Provisions Relating to the
Year 2000
iii. Deletion of Paragraph (i)(5) of Rule 17a–
5
iv. Amendments to Paragraph (f)(2) of Rule
17a–5
v. Further Technical Amendments
H. Coordination With Investment Advisers
Act Rule 206(4)–2
1. Background
2. Rule 206(4)–2
3. Broker-Dealers Acting as Qualified
Custodians Under Rule 206(4)–2
4. Proposal To Allow Report Based on
Examination of Compliance Report to
Satisfy Rule 206(4)–2
i. The Proposal
ii. Comments on the Proposal
5. Adoption of Proposal Relating to Rule
206(4)–2
III. Access to Accountant and Audit
Documentation
IV. Form Custody
A. Background
B. Filing of Form Custody
1. Requirement to File Form Custody with
FOCUS Reports
2. Requests for Exemption From Filing
Form Custody
3. Attest Engagement Not Required for
Form Custody
C. Form Custody
1. Item 1—Accounts Introduced on a Fully
Disclosed Basis
2. Item 2—Accounts Introduced on an
Omnibus Basis
3. Item 3—Carrying Broker-Dealers
i. Items 3.A and 3.B
ii. Item 3.C
a. Background
b. General Comments to Item 3.C
c. Item 3.C.i
d. Item 3.C.ii
e. Item 3.C.iii
iii. Items 3.D and 3.E
a. Items 3.D.i and 3.E.i
b. Items 3.D.ii and 3.E.ii
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c. Items 3.D.iii and 3.E.iii
4. Item 4—Carrying for Other BrokerDealers
5. Item 5—Trade Confirmations
6. Item 6—Account Statements
7. Item 7—Electronic Access to Account
Information
8. Item 8—Broker-Dealers Registered as
Investment Advisers
9. Item 9—Broker-Dealers Affiliated with
Investment Advisers
V. Effective Dates
A. Amendments Effective 60 Days After
Publication in the Federal Register
B. Amendments Effective on December 31,
2013
C. Amendments Effective on June 1, 2014
VI. Paperwork Reduction Act
A. Summary of the Collection of
Information Requirements
B. Use of Information
C. Respondents
D. Total Initial and Annual Burdens
1. Annual Reports To Be Filed
i. The Financial Report
ii. The Compliance Report
iii. The Exemption Report
iv. Additional Burden and Cost To File the
Annual Reports
v. Supplemental Report on SIPC
Membership
vi. Statement Regarding Independent
Public Accountant
vii. External Costs of Engagement of
Accountant
a. Financial Report (including Change from
GAAS to PCAOB Standards)
b. Compliance Report
c. Exemption Report
d. Access to Accountant and Audit
Documentation
2. Conforming and Technical Amendments
to Rule 17a–11
3. Form Custody
E. Collection of Information Is Mandatory
F. Confidentiality
VII. Economic Analysis
A. Motivation for the Amendments
B. Economic Baseline
1. Broker-Dealers
2. Independent Public Accountants That
Audit Broker-Dealer Reports
3. SIPC Lawsuits Against Accountants
4. Overview of Broker-Dealer Reporting,
Auditing, and Notification Requirements
Before Today’s Amendments
i. Broker-Dealer Reporting
ii. Engagement of the Accountant
iii. Filing of Annual Reports with SIPC
iv. Notification Requirements
v. Information Provided to Customers
vi. Access to Accountants and Audit
Documentation
vii. Form Custody
C. Costs and Benefits of the Rule
Amendments
1. Broker-Dealer Annual Reporting
Amendments
i. Changing the Broker-Dealer Audit
Standard Setter From the AICPA to the
PCAOB and the Standards From GAAS
to PCAOB Standards
ii. Requirement To File New Reports
a. Compliance Report
b. Exemption Report
iii. Engagement of the Accountant
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iv. Filing of Annual Reports With SIPC
v. Notification Requirements
a. Amendments to Rule 17a–5
b. Conforming and Technical Amendments
to Rule 17a–11
vi. Information Provided to Customers
vii. Coordination With Investment
Advisers Act Rule 206(4)–2
2. Access to Accountant and Audit
Documentation
3. Form Custody
4. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
VIII. Final Regulatory Flexibility Analysis
A. Need for and Objectives of the
Amendments and New Form
B. Significant Issues Raised by Public
Comments
C. Small Entities Subject to the Rules
D. Reporting, Recordkeeping, and Other
Compliance Requirements
E. Agency Action To Minimize Effect on
Small Entities
IX. Statutory Authority
I. Background
A. Overview
In 2009, the Commission began
reviewing rules regarding the
safekeeping of investor assets in
connection with several cases the
Commission brought alleging fraudulent
conduct by investment advisers and
broker-dealers, including, among other
things, misappropriation or other
misuse of customer securities and
funds.1 As part of the rule review effort,
the Commission amended Rule 206(4)–
2 under the Investment Advisers Act of
1940 (‘‘Rule 206(4)–2’’), which governs
the custody of client securities and
funds by investment advisers.2 When
adopting this amendment, the
Commission stated that it represented
‘‘a first step in the effort to enhance
custody protections, with consideration
of additional enhancements of the rules
governing custody of customer assets by
broker-dealers to follow.’’ 3
In June 2011, the Commission
proposed rule amendments and a new
form designed, among other things, to
provide additional safeguards with
1 See, e.g., SEC v. Bernard L. Madoff, et al.,
Litigation Release No. 20889 (Feb. 9, 2009); SEC v.
Stanford International Bank, et al., Litigation
Release No. 20901 (Feb. 17, 2009); SEC v. Donald
Anthony Walker Young, et al., Litigation Release
No. 21006 (Apr. 20, 2009); SEC v. Isaac I. Ovid, et
al., Litigation Release No. 20998 (Apr. 14, 2009);
SEC v. The Nutmeg Group, LLC, et al., Litigation
Release No. 20972 (Mar. 25, 2009); SEC v. WG
Trading Investors, L.P., et al., Litigation Release No.
20912 (Feb. 25, 2009).
2 See Custody of Funds or Securities of Clients by
Investment Advisers, Investment Advisers Act of
1940 (‘‘Advisers Act’’) Release No. 2968 (Dec. 30,
2009), 75 FR 1456 (Jan. 11, 2010). See also 17 CFR
275.206(4)–2.
3 See Custody of Funds or Securities of Clients by
Investment Advisers, 75 FR at 1456.
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51911
respect to broker-dealer custody of
customer securities and funds.4 The
proposed amendments would have
amended certain annual reporting,
audit, and notification requirements for
broker-dealers.5 The proposed
amendments also would have required
a broker-dealer that clears transactions
or carries customer accounts (each, a
‘‘clearing broker-dealer’’) to agree to
allow representatives of the Commission
or the broker-dealer’s DEA to review the
documentation associated with certain
reports of the broker-dealer’s
independent public accountant and to
allow the accountant to discuss with
representatives of the Commission or
DEA the accountant’s findings
associated with those reports when
requested in connection with an
examination of the broker-dealer.6
Further, the proposed amendments
would have required a broker-dealer to
file with its DEA on a quarterly basis a
new form—Form Custody—that would
have elicited information as to whether,
and if so how, a broker-dealer maintains
custody of securities and funds of
customers and others.7 The Commission
also proposed requiring that a brokerdealer file its annual reports with the
Securities Investor Protection
Corporation (‘‘SIPC’’).8
The proposed amendments were
designed to enhance the ability of the
Commission to oversee broker-dealer
custody practices and, among other
things, to: (1) Increase the focus of
broker-dealers that maintain custody of
customer funds and securities
(‘‘carrying broker-dealers’’) and their
independent public accountants on
compliance, and internal control over
compliance, with certain financial and
custodial requirements; (2) strengthen
and clarify broker-dealer audit and
reporting requirements in order to
facilitate consistent compliance with
these requirements; (3) facilitate the
ability of the PCAOB to implement the
explicit oversight authority over brokerdealer audits provided to the PCAOB by
the Dodd-Frank Act; 9 (4) ensure that
SIPC receives the necessary information
to assess whether the liquidation fund it
maintains is appropriately sized to the
risks of a large broker-dealer failure; (5)
enable Commission and DEA examiners
to conduct risk-based examinations of
carrying and clearing broker-dealers by
4 See Broker-Dealer Reports, Exchange Act
Release No. 64676 (June 15, 2011), 76 FR 37572
(June 27, 2011).
5 Id. at 37575–37583.
6 Id. at 37583–37584.
7 Id. at 37584–37592.
8 Id. at 37592–37594.
9 Public Law 111–203, 124 Stat. 1376, H.R. 4173
(July 21, 2010).
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assisting the examiners in selecting
areas of focus for their examinations;
and (6) provide the Commission and the
DEAs with a comprehensive overview of
a broker-dealer’s custody practices.10
The Commission received 27
comment letters on the proposal.11 The
Commission has considered the
comments and, as discussed in detail
below, is adopting the amendments and
the new form with modifications, in
part in response to comments received.
A number of commenters stated that the
Commission should coordinate with the
Commodity Futures Trading
Commission (‘‘CFTC’’) to account for
broker-dealers that also are registered as
futures commission merchants
(‘‘FCMs’’) in order to align the brokerdealer reporting and audit requirements
10 The proposed amendments also were designed
to avoid duplicative requirements for broker-dealers
that are dually-registered as investment advisers in
view of the internal control report requirement that
was added by the amendment to Rule 206(4)–2. See
discussion below in section VII.A. of this release
identifying further motivations for the amendments.
11 Comment letter of Naphtali M. Hamlet (June 22,
2011) (‘‘Hamlet Letter’’); comment letter of Robert
R. Kelley (June 27, 2011) (‘‘Kelley Letter’’); comment
letter of Chris Barnard (July 20, 2011) (‘‘Barnard
Letter’’); comment letter of Suzanne Shatto (July 25,
2011) (‘‘Shatto Letter’’); comment letter of Suzanne
H. Shatto (July 25, 2011) (‘‘Shatto Letter II’’);
comment letter of Todd Genger (Aug. 2, 2011)
(‘‘Genger Letter’’); comment letter of Suzanne Shatto
(Aug. 14, 2011) (‘‘Shatto Letter III’’); comment letter
of Deloitte & Touche LLP (Aug. 25, 2011) (‘‘Deloitte
Letter’’); comment letter of the Securities Industry
and Financial Markets Association (Aug. 25, 2011)
(‘‘SIFMA Letter’’); comment letter of the Center for
Audit Quality (Aug. 25, 2011) (‘‘CAQ Letter’’);
comment letter of KPMG LLP (Aug. 25, 2011)
(‘‘KPMG Letter’’); comment letter of
PricewaterhouseCoopers, LLP (Aug. 25, 2011)
(‘‘PWC Letter’’); comment letter of Citrin
Cooperman & Co., LLP (Aug. 25, 2011) (‘‘Citrin
Letter’’); comment letter of Grant Thornton LLP
(Aug. 26, 2011) (‘‘Grant Thornton Letter’’); comment
letter of James J. Angel (Aug. 26, 2011) (‘‘Angel
Letter’’); comment letter of James J. Angel (Aug. 26,
2011) (‘‘Angel Letter II’’); comment letter of
McGladrey & Pullen, LLP (Aug. 26, 2011)
(‘‘McGladrey Letter’’); comment letter of the
Certified Financial Planner Board of Standards, Inc.
(Aug. 26, 2011) (‘‘CFP Letter’’); comment letter of
Integrated Management Solutions USA LLC (Aug.
26, 2011) (‘‘IMS Letter’’); comment letter of the
American Institute of Certified Public Accountants
(Aug. 26, 2011) (‘‘AICPA Letter’’); comment letter of
the Committee of Annuity Insurers (Aug. 26, 2011)
(‘‘CAI Letter’’); comment letter of Ernst & Young
LLP (Aug. 26, 2011) (‘‘E&Y Letter’’); comment letter
of Van Kampen Funds Inc. and Invesco
Distributors, Inc. (Aug. 26, 2011) (‘‘Van Kampen/
Invesco Letter’’); comment letter of Suzanne H.
Shatto (Sept. 13, 2011) (‘‘Shatto Letter IV); comment
letter N.M. Hamlet (Sept. 14, 2011) (‘‘Hamlet Letter
II’’); comment letter of the Federal Regulation of
Securities Committee, Business Law Section,
American Bar Association (Sept. 15, 2011) (‘‘ABA
Letter’’); and comment letter of the Committee of
Annuity Insurers (Apr. 17, 2012) (‘‘CAI II Letter’’).
The comment letters are available on the
Commission’s Web site at https://www.sec.gov/
comments/s7-23-11/s72311.shtml. Comments are
also available for Web site viewing and printing in
the Commission’s Public Reference Room, 100 F
Street NE., Washington, DC (File No. S7–23–11).
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with FCM reporting and audit
requirements.12 The Commission staff is
in discussions with the CFTC staff
concerning ways to align the reporting
and audit requirements for duallyregistered broker-dealer/FCMs with the
goal of coordinating these requirements,
including the requirements that the
Commission is adopting today.
B. Rules Governing Broker-Dealer
Financial and Custodial Responsibility
Rule 15c3–1,13 Rule 15c3–3,14 and
Rule 17a–13,15 under the Exchange Act
and applicable DEA rules that require
broker-dealers to periodically send
account statements to customers
(‘‘Account Statement Rules’’) 16
(collectively for the purposes of this
release, ‘‘the financial responsibility
rules’’) are central to today’s
amendments to the broker-dealer
reporting, audit, and notification
requirements. In light of the significance
of the financial responsibility rules to
today’s amendments, the following
section briefly summarizes the
requirements of each rule in order to
provide a foundation for the later
discussion of the amendments.
1. The Broker-Dealer Net Capital Rule
Rule 15c3–1 requires broker-dealers to
maintain a minimum level of net capital
(consisting of highly liquid assets) at all
times.17 In computing net capital, a
broker-dealer must, among other things,
calculate net worth in accordance with
U.S. generally accepted accounting
principles (‘‘GAAP’’) and then make
certain adjustments to net worth, such
as deducting illiquid assets and taking
other capital charges and adding
qualifying subordinated loans.18 The
amount remaining after these
deductions is defined as ‘‘tentative net
12 See CAQ Letter; Deloitte Letter; E&Y Letter;
Grant Thornton Letter; KPMG Letter; PWC Letter.
13 17 CFR 240.15c3–1 (a rule prescribing net
capital requirements for broker-dealers).
14 17 CFR 240.15c3–3 (a rule prescribing
requirements regarding the holding of customer
securities and funds by broker-dealers).
15 17 CFR 240.17a–13 (a rule requiring brokerdealers to perform quarterly securities counts).
16 See, e.g., Rule 9.12 of the Chicago Board
Options Exchange (‘‘CBOE’’); NASD Rule 2340 of
the Financial Industry Regulatory Authoirty
(‘‘FINRA’’).
17 See 17 CFR 240.15c3–1. The rule requires that
a broker-dealer perform two calculations: (1) A
computation of the minimum amount of net capital
the broker-dealer must maintain; and (2) a
computation of the amount of net capital the
broker-dealer is maintaining. See 17 CFR 240.15c3–
1(a) and (c)(2). The computation of net capital is
based on the definition of the term ‘‘net capital’’ in
paragraph (c)(2) of Rule 15c3–1. Id. Generally, a
broker-dealer’s minimum net capital requirement is
the greater of a fixed-dollar amount specified in the
rule and an amount determined by applying one of
two financial ratios. See 17 CFR 240.15c3–1(a).
18 See 17 CFR 240.15c3–1(c)(2)(i)–(xiii).
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capital.’’ 19 The final step in computing
net capital is to deduct certain
percentages (‘‘haircuts’’) from the
market value of the broker-dealer’s
proprietary positions to account for the
market risk inherent in the positions 20
and to create a buffer of liquidity to
protect against other risks associated
with the broker-dealer’s business.21 The
broker-dealer must cease conducting a
securities business if the amount of net
capital maintained by the firm falls
below the minimum required amount.22
2. The Broker-Dealer Customer
Protection Rule
Rule 15c3–3 imposes two key
requirements on a carrying brokerdealer: first, the broker-dealer must
maintain physical possession or control
over customers’ fully paid and excess
margin securities; 23 and second, the
firm must maintain a reserve of funds or
qualified securities 24 in an account at
one or more banks that is at least equal
in value to the amount of net funds
owed to customers.25 These
requirements are designed to protect
customers by requiring broker-dealers to
segregate customers’ securities and
19 See
17 CFR 240.15c3–1(c)(15).
17 CFR 240.15c3–1(c)(2)(vi).
21 See, e.g., Uniform Net Capital Rule, Exchange
Act Release No. 13635 (June 16, 1977), 42 FR 31778
(June 23, 1977).
22 See 15 U.S.C. 78o(c)(3)(A).
23 See 17 CFR 240.15c3–3(d). Control means the
broker-dealer must hold these securities free of lien
in one of several locations specified in the rule (e.g.,
at a bank or clearing agency). See 17 CFR 240.15c3–
3(c). The broker-dealer must make a daily
determination from its books and records (as of the
preceding day) of the quantity of fully paid and
excess margin securities not in its possession or
control. See 17 CFR 240.15c3–3(d). If the amount
in the broker-dealer’s possession or control is less
than the amount indicated as being held for
customers on the broker-dealer’s books and records,
the broker-dealer generally must initiate steps to
retrieve customer securities from non-control
locations or otherwise obtain possession of them or
place them in control locations. Id. The terms fully
paid securities, margin securities, and excess
margin securities are defined in Rule 15c3–3. See
17 CFR 240.15c3–3(a)(3), (a)(4), and (a)(5),
respectively.
24 The term qualified security is defined in Rule
15c3–3 to mean a security issued by the U.S. or a
security in respect of which the principal and
interest are guaranteed by the U.S. See 17 CFR
240.15c3–3(a)(6).
25 See 17 CFR 240.15c3–3(e). The amount of the
net funds owed to customers (‘‘customer reserve
requirement’’) is computed by adding customer
credit items (e.g., cash in securities accounts) and
subtracting from that amount customer debit items
(e.g., margin loans) pursuant to a formula in Exhibit
A to Rule 15c3–3. See 17 CFR 240.15c3–3a.
Carrying broker-dealers are required to compute the
customer reserve requirement on a weekly basis,
except where customer credit balances do not
exceed $1 million (in which case the computation
can be performed monthly, although the brokerdealer must maintain 105% of the required deposit
amount and may not exceed a specified aggregate
indebtedness limit). See 17 CFR 240.15c3–3(e)(3).
20 See
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funds from the broker-dealer’s
proprietary business activities. If the
broker-dealer fails financially,
customers’ securities and funds should
be readily available to be returned to
customers. In addition, if the failed
broker-dealer is liquidated in a
proceeding under the Securities Investor
Protection Act of 1970 (‘‘SIPA’’), as
amended, the customers’ securities and
funds should be isolated and readily
identifiable as ‘‘customer property’’ and,
consequently, available to be distributed
to customers ahead of other creditors.26
Provisions of Rule 15c3–3 exempt a
broker-dealer from the requirements of
Rule 15c3–3 under certain
circumstances.27 Generally, a brokerdealer is exempt from Rule 15c3–3 if it
does not hold customer securities or
funds, or, if it does receive customer
securities or funds, it promptly delivers
the securities or promptly transmits the
funds to appropriate persons.28
3. The Broker-Dealer Quarterly
Securities Count Rule
Rule 17a–13 generally requires a
broker-dealer that maintains custody of
securities (proprietary, customer, or
both), on a quarterly basis, to physically
examine and count the securities it
holds, account for the securities that are
subject to its control or direction but are
not in its physical possession (e.g.,
securities held at a control location),
verify the locations of securities under
certain circumstances, and compare the
results of the count and verification
with its records.29 In accordance with a
schedule, the broker-dealer must take an
operational capital charge under Rule
15c3–1 for short securities differences
(which include securities positions
reflected on the broker-dealer’s
securities record that are not susceptible
to either count or confirmation) that are
unresolved after discovery.30 The
differences also must be recorded in the
broker-dealer’s books and records.31
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4. The Broker-Dealer Account Statement
Rules
The Account Statement Rules of DEAs
require member broker-dealers to send,
at least once every calendar quarter, a
statement of account containing a
description of any securities positions,
money balances, or account activity to
each customer whose account had a
security position, money balance, or
account activity during the period since
A. Overview of New Requirements
The Commission is adopting
amendments to the reporting, audit, and
notification requirements in Rule 17a–5,
and additional amendments to other
provisions of the rule, including
technical changes. The Commission also
is adopting amendments to the
notification requirements in Rule 17a–
11, and certain other technical
amendments to that rule.
Under the amendments to the
reporting and audit requirements,
broker-dealers must, among other
things, file with the Commission annual
reports consisting of a financial report
and either a compliance report or an
exemption report that are prepared by
the broker-dealer, as well as certain
reports that are prepared by an
independent public accountant covering
the financial report and the compliance
report or the exemption report.33 The
filing of a compliance or exemption
report and the related report of the
independent public accountant are new
requirements. The financial report must
contain the same types of financial
statements that were required to be filed
under Rule 17a–5 prior to these
amendments (a statement of financial
condition, a statement of income, a
statement of cash flows, and certain
other financial statements).34 In
addition, the financial report must
contain, as applicable, the supporting
schedules that were required to be filed
under Rule 17a–5 prior to these
amendments (a computation of net
capital under Rule 15c3–1, a
computation of the reserve requirements
under Rule 15c3–3, and information
relating to the possession or control
requirements under Rule 15c3–3).35
A broker-dealer that did not claim
that it was exempt from Rule 15c3–3
throughout the most recent fiscal year
e.g., CBOE Rule 9.12; NASD Rule 2340.
paragraph (d) of Rule 17a–5.
34 See paragraph (d)(2)(i) of Rule 17a–5. The
requirements for the financial report are discussed
below in more detail in section II.B.2. of this
release.
35 See paragraph (d)(2)(ii) of Rule 17a–5.
15 U.S.C. 78aaa et seq.
27 See 17 CFR 240.15c3–3(k).
28 Id.
29 See 17 CFR 240.17a–13(b).
30 See 17 CFR 240.15c3–1(c)(2)(v).
31 See 17 CFR 240.17a–3(a)(4)(vi).
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II. Final Amendments to Broker-Dealer
Reporting, Audit, Notification, and
Other Requirements
32 See,
26 See
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the last such statement was sent to the
customer.32 The Account Statement
Rules provide a key safeguard for
customers by requiring that they receive
information concerning securities
positions and other assets held in their
accounts on a regular basis, which they
can use to identify discrepancies and
monitor the performance of their
accounts.
33 See
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51913
must file the compliance report, and a
broker-dealer that did claim it was
exempt from Rule 15c3–3 throughout
the most recent fiscal year (generally, a
‘‘non-carrying broker-dealer’’) must file
the exemption report.36 Broker-dealers
must make certain statements and
provide certain information relating to
the financial responsibility rules in
these reports.37
In addition to preparing and filing the
financial report and the compliance
report or exemption report, a brokerdealer must engage a PCAOB-registered
independent public accountant to
prepare a report based on an
examination of the broker-dealer’s
financial report in accordance with
PCAOB standards.38 A carrying brokerdealer also must engage the PCAOBregistered independent public
accountant to prepare a report based on
an examination of certain statements in
the broker-dealer’s compliance report.39
A non-carrying broker-dealer must
engage the PCAOB-registered
independent public accountant to
prepare a report based on a review of
certain statements in the broker-dealer’s
exemption report.40 In each case, the
examination or review must be
conducted in accordance with PCAOB
standards. The broker-dealer must file
these reports with the Commission
along with the financial report and the
compliance report or exemption report
prepared by the broker-dealer.41
The annual reports also must be filed
with SIPC if the broker-dealer is a
member of SIPC.42 In addition, brokerdealers must generally file with SIPC a
supplemental report on the status of the
membership of the broker-dealer in
SIPC.43 The supplemental report must
include a report of the independent
public accountant that covers the SIPC
annual general assessment
reconciliation or exclusion from
membership forms based on certain
36 See paragraphs (d)(1)(i)(B)(1) and (2) of Rule
17a–5.
37 See paragraphs (d)(3) and (4) of Rule 17a–5.
The requirements for the compliance report and the
exemption report are discussed below in more
detail in section II.B.3. and section II.B.4. of this
release, respectively.
38 See paragraphs (f)(1) and (g)(1) of Rule 17a–5.
39 See paragraphs (f)(1) and (g)(2)(i) of Rule 17a–
5.
40 See paragraphs (f)(1) and (g)(2)(ii) of Rule 17a–
5.
41 See paragraph (d)(1)(i)(C) of Rule 17a–5. The
requirements for the engagement of the
independent public accountant are discussed below
in more detail in section II.D.3. of this release.
42 See paragraph (d)(6) of Rule 17a–5. This
requirement is discussed below in more detail in
section II.B.6. of this release.
43 See paragraph (e)(4) of Rule 17a–5. This
requirement is discussed below in more detail in
section II.C.4. of this release.
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procedures specified in the rule. In the
future, SIPC may determine the format
of this report by rule, subject to
Commission approval.44
Finally, the PCAOB-registered
independent public accountant must
immediately notify the broker-dealer if
the accountant determines during the
course of preparing the accountant’s
reports that the broker-dealer is not in
compliance with the financial
responsibility rules or if the accountant
determines that any material weakness
exists in the broker-dealer’s internal
control over compliance with the
financial responsibility rules.45 The
broker-dealer, in turn, must file a
notification with the Commission and
its DEA under Rule 15c3–1, Rule 15c3–
3, or Rule 17a–11 if the independent
public accountant’s notice concerns an
instance of non-compliance that would
trigger notification under those rules.46
Under the amendments to Rule 17a–11,
a broker-dealer also must file a
notification with the Commission and
its DEA if the broker-dealer discovers or
is notified by the independent public
accountant of the existence of any
material weakness (as defined in the
amendments) in the broker-dealer’s
internal control over compliance with
the financial responsibility rules.47
Each of these amendments is
discussed in more detail in the
following sections of this release.
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B. Annual Reports To Be Filed—
Paragraph (d) of Rule 17a–5
Prior to today’s amendments,
paragraph (d) of Rule 17a–5 generally
required a broker-dealer to annually file
the financial statements and supporting
schedules discussed below in section
II.B.2. of this release and a report
prepared by the broker-dealer’s
independent public accountant covering
the financial statements and supporting
schedules.48 The Commission proposed
amendments that would, among other
things, restructure paragraph (d) and—
44 Id. Currently, Rule 17a–5 prescribes the format
of the report. See 17 CFR 240.17a–5.
45 See paragraph (h) of Rule 17a–5. As discussed
below, material weakness is defined for purposes of
the compliance report and, therefore, the
notification of a material weakness only can occur
in the context of the audit of a broker-dealer that
files a compliance report.
46 Id. Notifications under Rule 17a–11 also must
be filed with the CFTC if the broker-dealer is
registered as a FCM with the CFTC. See 17 CFR
240.17a–11(g).
47 See paragraph (e) of Rule 17a–11. These
notification provisions are discussed below in more
detail in section II.F. of this release.
48 See 17 CFR 240.17a–5(d)(1)(i). Certain types of
broker-dealers were exempt from the requirement to
file the reports or to file reports that had been
audited by an independent public accountant. See
17 CFR 240.17a–5(d)(1)(ii)–(iii).
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as part of the proposed revisions to the
attestation engagement provisions—add
the requirement that a broker-dealer file
either a compliance report or an
exemption report, as applicable, and a
report prepared by the broker-dealer’s
independent public accountant based
on an examination of the compliance
report or a review of the exemption
report.49 As discussed in sections II.B.1.
through II.B.6. of this release, the
Commission is adopting the proposed
amendments to paragraph (d) with
modifications.50
1. Requirement To File Reports—
Paragraph (d)(1) of Rule 17a–5
i. Proposed Amendments
The Commission proposed to amend
paragraph (d)(1) of Rule 17a–5 51 to
require that a broker-dealer file a
financial report containing financial
statements and supporting schedules
and either a compliance report or an
exemption report, as applicable.52 The
proposal provided that a broker-dealer
must file a compliance report ‘‘unless
the [broker-dealer] is exempt from the
provisions of [Rule 15c3–3]’’ in which
case the broker-dealer would be
required to file an exemption report.53
The proposed amendments also would
have required a broker-dealer generally
to file reports prepared by an
independent public accountant covering
the financial report and compliance
report or exemption report, as
applicable, unless the broker-dealer was
exempt from the requirement to file the
reports or from the requirement to
engage an independent public
accountant with respect to the reports.54
To accommodate these changes, the
Commission also proposed to reorganize
the provisions of paragraph (d)(1) of
49 See Broker-Dealer Reports, 76 FR at 37575–
37581.
50 Before today’s amendments, paragraph (d) of
Rule 17a–5 was titled ‘‘Annual filing of audited
financial statements.’’ In the proposing release, the
Commission proposed to change the title to
‘‘Annual reports’’ to reflect that, under the proposed
amendments to paragraph (d), broker-dealers would
be required to prepare and file two reports with the
Commission—a financial report and a compliance
report or an exemption report. See Broker-Dealer
Reports, 76 FR at 37575. The Commission received
no comments on this proposal and is adopting the
new title as proposed. See paragraph (d) of Rule
17a–5. In addition, the Commission is making a
technical amendment to paragraph (d) of Rule 17a–
5 to replace the term ‘‘fiscal or calendar year’’ with
the term ‘‘fiscal year.’’ The Commission is adopting
this technical amendment because the term ‘‘fiscal
year’’ includes instances in which December 31st,
i.e., the calendar year end, is the broker-dealer’s
fiscal year end.
51 See 17 CFR 240.17a–5(d)(1).
52 See Broker-Dealer Reports, 76 FR at 37575.
53 Id.
54 Id.
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Rule 17a–5, and to make other technical
amendments.55
The proposed amendments with
respect to the compliance report and
exemption report set forth different
requirements for carrying broker-dealers
as compared with broker-dealers that do
not hold customer securities and
funds.56 In order to provide clarity with
respect to this distinction, the proposed
amendments referenced Rule 15c3–3,
which applies to carrying broker-dealers
and contains provisions under which a
broker-dealer is exempt from the
requirements in the rule. The goal was
to establish a clear way of determining
whether a broker-dealer would need to
file a compliance report or an
exemption report. However, not all
broker-dealers that are subject to Rule
15c3–3 regularly hold customer
securities or funds. This prompted the
Commission to inquire in the proposing
release as to whether there are brokerdealers that would not qualify to file the
proposed exemption report because they
are not exempt from Rule 15c3–3, but
that should be allowed to file a more
limited report than the proposed
compliance report based on the limited
scope of their business.57
ii. Comments Received
The Commission received several
comments on its proposed amendments
to paragraph (d)(1) of Rule 17a–5.58
Some commenters asked whether the
provision that would require the brokerdealer to file an exemption report
instead of a compliance report related to
a period end date or to a period of
time.59 Further, as discussed in more
detail in sections II.B.4. and II.D.3. of
this release, commenters raised
questions and concerns about how
instances of exceptions to meeting the
exemption provisions of paragraph (k)
of Rule 15c3–3 would be treated under
the proposed reporting requirements.60
One commenter also stated that ‘‘limited
purpose’’ carrying broker-dealers should
not be required to file a compliance
report, and broker-dealers with certain
business model characteristics should
not be required to file the compliance
report.61 Similarly, another commenter
stated that broker-dealers engaging
55 Id.
at 37575–37578, 37603–37604.
at 37575–37578, 37580–37581 (discussing
the compliance report and exemption report,
respectively).
57 Id. at 37581.
58 See, e.g., CAI Letter; CAI II Letter; CAQ Letter;
Citrin Letter; Deloitte Letter; Grant Thornton Letter;
KPMG Letter; McGladrey Letter.
59 See CAQ Letter; Deloitte Letter; Grant Thornton
Letter; KPMG Letter.
60 See CAI Letter; SIFMA Letter.
61 See CAI Letter; CAI II Letter.
56 Id.
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exclusively in proprietary trading or
investment banking may not technically
be exempt from Rule 15c3–3 but
nonetheless should not have to file the
compliance report as they do not have
‘‘customers.’’ 62 Finally, one commenter
stated that the Commission should
clarify who must sign the compliance
reports and exemption reports and the
liability that attaches in the event of a
misstatement or omission in the
reports.63
iii. The Final Rule
After considering these comments, the
Commission is adopting the proposed
amendments with certain
modifications.64 Under the final rule, all
62 See
McGladrey Letter.
CAI Letter.
64 See paragraph (d)(1) of Rule 17a–5. Paragraph
(d)(1)(iii) of Rule 17a–5 (now re-designated as
paragraph (d)(1)(iv)) contains an exemption from
filing an annual report if the broker-dealer is a
member of a national securities exchange and has
transacted business in securities solely with or for
other members of a national securities exchange,
and has not carried any margin account, credit
balance or security for any person who is defined
as a ‘‘customer’’ in paragraph (c)(4) of Rule 17a–5.
See paragraph (d)(1)(iv) of Rule 17a–5. The
Commission also proposed to move the exemptions
from having to file financial statements under
paragraph (d) of Rule 17a–5 from paragraphs
(d)(1)(ii) and (d)(1)(iii) of Rule 17a–5 to paragraphs
(d)(1)(iii) and (d)(1)(iv), respectively. The
Commission received no comments on these
amendments and is adopting them as proposed. See
paragraphs (d)(1)(iii) and (d)(1)(iv) of Rule 17a–5.
For clarity, the amendments to paragraph (d)(1)(i)
of Rule 17a–5 include a reference to the exemptions
from the requirement for a broker-dealer to file the
annual reports so that the paragraph now states
‘‘[e]xcept as provided in paragraphs (d)(1)(iii) and
(d)(1)(iv) of this section, every broker or dealer
registered under section 15 of the Act must file
annually . . . .’’ See paragraph (d)(1)(i) of Rule 17a–
5. As proposed, the final rule provided that the
reports must be filed annually ‘‘on a calendar or
fiscal year basis.’’ The final rule deletes the phrase
‘‘on a calendar or fiscal year basis’’ as the rule
provides elsewhere that the annual reports must be
filed on a fiscal year basis. Id. In addition, the
Commission proposed to move the requirement that
reports under paragraph (d) of Rule 17a–5 be as of
the same fixed or determinable date each year,
unless a change is approved in writing by the
broker-dealer’s DEA, from paragraph (d)(1)(i) of
Rule 17a–5 to paragraph (d)(1)(ii). The Commission
received no comments on this proposed
amendment and is adopting it substantially as
proposed. See paragraph (d)(1)(ii) of Rule 17a–5.
The final rule also includes a technical
modification from the proposal to require that the
reports required to be filed under paragraph (d)
must be as of the same ‘‘fiscal year end each year,’’
rather than as of the same ‘‘fixed or determinable
date each year.’’ See paragraph (d)(1)(ii) of Rule
17a–5. This change, by having the rule refer to the
broker-dealer’s ‘‘fiscal year,’’ eliminates outdated
language and conforms the language in paragraph
(d) of Rule 17a–5 to language in paragraph (n) of
Rule 17a–5. See 17 CFR 240.17a–5(n). The final rule
also adds a clarifying cross-reference to the
provision in Rule 17a–5 pursuant to which a
broker-dealer requests a change of its fiscal year
end. See paragraph (d)(1)(i) of Rule 17a–5.
Furthermore, the final rule requires that a copy of
the written approval by the broker-dealer’s DEA of
a change in the broker-dealer’s fiscal year be sent
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63 See
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broker-dealers generally must prepare
and file a financial report and either the
compliance report or the exemption
report.65 A broker-dealer that did not
claim an exemption from Rule 15c3–3 at
any time during the most recent fiscal
year or claimed an exemption for only
part of the fiscal year must prepare and
file the compliance report.66 A brokerdealer must prepare and file the
exemption report if the firm did claim
that it was exempt from Rule 15c3–3
throughout the most recent fiscal year.67
Broker-dealers also must file reports
prepared by a PCAOB-registered
independent public accountant covering
the financial report and the compliance
report or exemption report, as
applicable.68
The final rule is modified from the
proposal in three key ways. First, the
final rule provides that the broker-dealer
must file the exemption report if it did
‘‘claim that it was exempt’’ from Rule
15c3–3 69 throughout the most recent
fiscal year.70 This modification from the
proposal—which provided that a
broker-dealer ‘‘shall’’ file the exemption
report if the broker-dealer ‘‘is exempt
from the provisions of [Rule 15c3–3]’’—
is designed to provide greater clarity as
to whether a broker-dealer must file the
exemption report (as opposed to the
compliance report), particularly when
the broker-dealer had exceptions to
meeting the exemption provisions in
paragraph (k) of Rule 15c3–3 during the
fiscal year.71 Specifically, if the brokerto the Commission’s principal office in Washington,
DC, in addition to the regional office of the
Commission for the region in which the brokerdealer has its principal place of business. Id. This
change is consistent with paragraph (n) of Rule
17a–5, which requires that when a broker-dealer
changes its fiscal year, it must file a notice with the
Commission’s principal office in Washington, DC as
well as the regional office of the Commission for the
region in which the broker-dealer has its principal
place of business. See 17 CFR 240.17a–5(n).
65 See paragraph (d)(1)(i) of Rule 17a–5. The
financial report, compliance report, and exemption
report are discussed below in more detail in
sections II.B.2., II.B.3., and II.B.4., respectively, of
this release.
66 See paragraph (d)(1)(i)(B)(1) of Rule 17a–5.
67 See paragraph (d)(1)(i)(B)(2) of Rule 17a–5.
68 See paragraph (d)(1)(i)(C) of Rule 17a–5. The
proposed requirements and final rule with respect
to the attestation engagement for the independent
public accountant are discussed below in section
II.D. of this release.
69 See paragraph (d)(1)(i)(B)(2) of Rule 17a–5. A
broker-dealer claiming an exemption from Rule
15c3–3 is required to indicate the basis for the
exemption on the periodic reports it files with
securities regulators. See, e.g., Item 24 of Part IIa of
the Financial and Operational Combined Uniform
Single Report. See 17 CFR 249.617.
70 As discussed below in more detail in section
II.B.4. of this release, the provisions of paragraph
(k) of Rule 15c3–3 prescribe ‘‘exemptions’’ from the
requirements of Rule 15c3–3. See 17 CFR 240.15c3–
3(k)(1), (k)(2)(i), (k)(2)(ii), and (k)(3).
71 See CAI Letter; SIFMA Letter.
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dealer claimed an exemption from Rule
15c3–3 in its Financial and Operational
Combined Uniform Single Reports
(‘‘FOCUS Reports’’) throughout the
fiscal year,72 it must file the exemption
report even it had exceptions to the
exemption provisions.73 Consequently,
the applicability of the exemption report
under the final rule is based on an
objective and easily ascertainable factor:
whether the broker-dealer claimed an
exemption from Rule 15c3–3 throughout
the most recent fiscal year.74
As noted above, several commenters
argued that broker-dealers that engage in
limited custodial activities and,
therefore, are not exempt from Rule
15c3–3, should not be required to file a
compliance report.75 Specifically, one of
these commenters suggested that a
‘‘new’’ category of ‘‘limited purpose’’
broker-dealer with certain business
model characteristics should be
addressed in the rule and that this
‘‘new’’ category of broker-dealer should
not be required to file the compliance
report.76 The Commission has
considered these comments but has
determined not to provide for a broader
exception from the requirement to file a
compliance report for broker-dealers
with limited custodial activities. The
objectives of the compliance report and
related examination of the compliance
report are intended, among other things,
to ‘‘increase the focus of independent
public accountants on the custody
practices of broker-dealers’’ and to
‘‘help identify broker-dealers that have
weak controls for safeguarding investor
assets.’’ 77 Therefore, broker-dealers that
hold customer assets—even if their
custodial activities are limited—
generally should be subject to the
requirement to file the compliance
report and related accountant’s report.78
72 The FOCUS Reports are: Form X–17A–5
Schedule I; Form X–17A–5 Part II; Form X–17A–
5 Part IIa; Form X–17A–5 Part IIb; and Form X–
17A–5 Part III.
73 As discussed in detail below in section II.B.4.
of this release, a broker-dealer that has exceptions
to meeting the exemption provisions in paragraph
(k) of Rule 15c3–3 must identify them in the
exemption report.
74 See discussion in section II.B.4. of this release.
There may be circumstances in which a brokerdealer has not held customer securities or funds
during the fiscal year, but does not fit into one of
the exemptive provisions listed under Item 24 of
Part IIa. Even though there is not a box to check
on the FOCUS Report, these broker-dealers should
file an exemption report and related accountant’s
report.
75 See, e.g., CAI Letter; CAI II Letter; McGladrey
Letter.
76 See CAI II Letter.
77 See Broker-Dealer Reports, 76 FR at 37599.
78 Broker-dealers with extremely limited
custodial activities (e.g., holding customer checks
made out to a third party for limited periods of
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The level of effort required by
carrying broker-dealers to prepare a
compliance report will depend on the
nature and extent of their activities. For
example, the controls of a carrying
broker-dealer that engages in limited
custodial activities could be less
complex than the controls of a carrying
broker-dealer that engages in more
extensive custodial activities.79
Therefore, this requirement is intended
to be scalable so that a carrying brokerdealer with limited custodial activities
generally should have to expend less
effort to support its statements in the
compliance report, particularly with
respect to the statements relating to
Rules 15c3–3 and 17a–13.
The second key modification is that
the final rule provides that the
requirement to file the exemption report
applies if the broker-dealer did claim
that it was exempt from Rule 15c3–3
‘‘throughout the most recent fiscal
year.’’ 80 Thus, a broker-dealer that did
not claim an exemption from Rule
15c3–3 at any time during the most
recent fiscal year or claimed an
exemption for only part of the fiscal
year must file the compliance report.81
The third key modification is that the
final rule specifies the individual who
must execute the compliance reports
and exemption reports.82 As noted
above, one commenter stated that the
Commission should make clear who
should sign the compliance reports and
exemption reports and what liability
time) could seek exemptive relief under section 36
of the Exchange Act (15 U.S.C. 77mm) from the
requirement to file the compliance report and report
of the independent public accountant covering the
compliance report.
79 As discussed below in section II.D. of this
release, the PCAOB has proposed attestation
standards for an independent public accountant’s
examination of the compliance report and the
review of the exemption report. The proposed
examination standard provides procedural
requirements for independent public accountants
that are ‘‘designed to be scalable based on the
broker’s or dealer’s size and complexity.’’ See
Proposed Standards for Attestation Engagements
Related to Broker and Dealer Compliance or
Exemption Reports Required by the U.S. Securities
and Exchange Commission and Related
Amendments to PCAOB Standards, PCAOB Release
No. 2011–004, PCAOB Rulemaking Docket Matter
No. 035 (July 12, 2011) at 8 (‘‘PCAOB Proposing
Release’’).
80 See paragraphs (d)(1)(i)(B)(1)–(2) of Rule
17a–5.
81 There will be cases where a broker-dealer
changes its business model to convert from a
carrying broker-dealer to a non-carrying brokerdealer during the fiscal year. In this case, the
broker-dealer could seek exemptive relief under
section 36 of the Exchange Act (15 U.S.C. 78mm)
from the requirement to file the compliance report
and to instead file the exemption report. In
analyzing such a request, the period of time the
broker-dealer operated as a carrying broker-dealer
would be a relevant consideration.
82 See paragraphs (d)(1)(i)(B)(1)–(2) of Rule
17a–5.
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attaches in the event of a misstatement
or omission.83 The commenter
suggested a reasonableness standard,
and stated that the Commission should
make clear that the reports do not create
a new private right of action.84 In
response to this comment, the final rule
provides that the compliance report and
the exemption report must be executed
by the person who makes the oath or
affirmation under paragraph (e)(2) of
Rule 17a–5.85 As discussed below in
more detail in section II.C.2. of this
release, paragraph (e)(2) of Rule 17a–5
requires an oath or affirmation to be
attached to the financial report and
provides that the oath or affirmation
must be made by certain types of
persons depending on the corporate
form of the broker-dealer (e.g., a duly
authorized officer if the broker-dealer is
a corporation).86 The requirement to file
these new reports with the Commission
is not intended to establish a new
private cause of action.
2. The Financial Report—Paragraph
(d)(2) of Rule 17a–5
Before today’s amendments,
paragraph (d)(2) of Rule 17a–5 required
that the annual audited report of a
broker-dealer contain certain financial
statements in a format consistent with
Form X–17A–5 Part II or Form X–17A–
5 Part IIa, as applicable, including a
statement of financial condition, an
income statement, a statement of cash
flows, a statement of changes in owners’
equity, and a statement of changes in
liabilities subordinated to claims of
general creditors.87 Paragraph (d)(3) of
Rule 17a–5 required that the annual
audited report contain supporting
83 See CAI Letter. The filings discussed above
constitute a ‘‘report’’ for purposes of 15 U.S.C.
78ff(a) and other applicable provisions of the
Exchange Act. As a consequence, it would be
unlawful for a broker-dealer to willfully make or
cause to be made, a false or misleading statement
of a material fact or omit to state a material fact in
the filings.
84 Id.
85 See paragraphs (d)(1)(i)(B)(1)–(2) of Rule 17a–
5.
86 See paragraph (e)(2) of Rule 17a–5.
87 See 17 CFR 240.17a–5(d)(2). As noted above,
Form X–17A–5 Part II and Form X–17A–5 Part IIa
are among the FOCUS Reports that broker-dealers
complete and file with the Commission or their
DEA on a periodic basis. See 17 CFR 240.17a–5(a)
and 17 CFR 249.617. These two forms require
broker-dealers to file monthly or quarterly financial
information with the Commission or their DEA,
including information about the broker-dealer’s: (1)
Assets and liabilities; ownership equity; net capital
computation under Rule 15c3–1; minimum net
capital requirement under Rule 15c3–1; income
(loss); computation of the customer reserve
requirement under Rule 15c3–3 in the case of Form
X–17A–5 Part II; the possession and control
requirements under Rule 15c3–3 in the case of
Form X–17A–5 Part II; and changes in ownership
equity.
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schedules, including a computation of
net capital under Rule 15c3–1, a
computation for determining reserve
requirements under Rule 15c3–3, and
information relating to the possession
and control requirements of Rule 15c3–
3.88 Paragraph (d)(4) of Rule 17a–5
required a reconciliation between the
net capital and reserve computations in
the audited report and those in the most
recent Form X–17A–5 Part II or Form X–
17A–5 Part IIa, if there were material
differences between the annual audited
report and the form.89
The Commission proposed combining
the provisions in paragraphs (d)(2)
through (d)(4) of Rule 17a–5 in revised
paragraph (d)(2) without substantive
modification to those provisions.90 In
addition, the Commission proposed that
revised paragraph (d)(2) be titled
‘‘Financial report’’ to reflect that the
information required in this report
would be financial in nature and to
differentiate it from the proposed
compliance reports and exemption
reports. The Commission did not
receive comments concerning the
amendments to paragraph (d)(2) of Rule
17a–5 and is adopting them
substantially as proposed.91
3. The Compliance Report—Paragraph
(d)(3) of Rule 17a–5
i. The Proposed Amendments
As proposed, the requirements for the
contents of the compliance report were
prescribed in paragraph (d)(3) of Rule
17a–5.92 Under the proposal, a carrying
broker-dealer would need to include in
the compliance report a specific
statement, certain assertions, and
descriptions.93 The independent public
accountant would examine the
assertions in the compliance report in
preparing the report of the accountant.94
88 See
17 CFR 240.17a–5(d)(3).
17 CFR 240.17a–5(d)(4).
90 See Broker-Dealer Reports, 76 FR at 37575.
91 See paragraph (d)(2) of Rule 17a–5. The
Commission has made plain English changes to the
language of the paragraph (e.g., replacing the term
‘‘shall’’ with ‘‘must’’). The Commission also,
consistent with current practice, has clarified that
the financial statements must be prepared in
accordance with U.S. GAAP to distinguish from
other accounting frameworks. See paragraph (d)(2)
of Rule 17a–5. In addition, the Commission has
replaced the words ‘‘notes to the consolidated
statement of financial condition’’ with ‘‘notes to the
financial statements.’’ This change in terminology
is designed to conform the language in Rule 17a–
5 to current accounting practice. Under GAAP,
notes to a complete set of financial statements must
cover all the financial statements, and not just one
of the statements, such as the consolidated
statement of financial condition.
92 See Broker-Dealer Reports, 76 FR at 37575–
37578.
93 Id.
94 Id. The independent public accountant would
not have been required to examine the proposed
89 See
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Specifically, as proposed, the carrying
broker-dealer would be required to
include in the compliance report a
statement as to whether the firm has
established and maintained a system of
internal control to provide the brokerdealer with reasonable assurance that
any instances of material noncompliance with the financial
responsibility rules will be prevented or
detected on a timely basis.95 In addition,
the compliance report would need to
include the following three assertions:
(1) Whether the broker-dealer was in
compliance in all material respects with
the financial responsibility rules as of
its fiscal year end; (2) whether the
information used to assert compliance
with the financial responsibility rules
was derived from the books and records
of the broker-dealer; and (3) whether
internal control over compliance with
the financial responsibility rules was
effective during the most recent fiscal
year such that there were no instances
of material weakness.96 Finally, the
carrying broker-dealer would need to
include in the compliance report a
description of each identified instance
of material non-compliance and each
identified material weakness in internal
control over compliance with the
financial responsibility rules.97 The
independent public accountant would
examine the assertions in preparing the
report of the accountant.98 The
independent public accountant would
not examine the statement regarding the
establishment of the system of internal
control.
Under the proposal, the broker-dealer
would not be able to assert compliance
with the financial responsibility rules as
of its most recent fiscal year end if it
identified one or more instances of
material non-compliance.99 Similarly,
the broker-dealer would not be able to
assert that its internal control over
compliance with the financial
responsibility rules during the fiscal
year was effective if one or more
material weaknesses existed with
‘‘statement’’ and descriptions in the compliance
report.
95 See Broker-Dealer Reports, 76 FR at 37575–
37576.
96 Id.
97 Id.
98 Id. GAAS and PCAOB standards for attestation
engagements provide that accountants ordinarily
should obtain written assertions in an examination
or review engagement. See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ¶ .09.
Accordingly, the Commission proposed that the
independent public accountant’s report cover only
the three assertions in the compliance report.
99 See Broker-Dealer Reports, 76 FR at 37576–
37577.
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respect to internal control over
compliance.100
An instance of material noncompliance was proposed to be defined
as a failure by the broker-dealer to
comply with any of the requirements of
the financial responsibility rules in all
material respects.101 When determining
whether an instance of non-compliance
is material, the Commission stated that
the broker-dealer should consider all
relevant factors including but not
limited to: (1) The nature of the
compliance requirements, which may or
may not be quantifiable in monetary
terms; (2) the nature and frequency of
non-compliance identified; and (3)
qualitative considerations.102 The
Commission also stated that some
deficiencies would necessarily be
instances of material non-compliance,
including failing to maintain the
required minimum amount of net
capital under Rule 15c3–1 or failing to
maintain the minimum deposit
requirement in a special reserve bank
account for the exclusive benefit of
customers under Rule 15c3–3.103
The term material weakness was
proposed to be defined as a deficiency,
or a combination of deficiencies, in
internal control over compliance with
the financial responsibility rules, such
that there is a reasonable possibility that
material non-compliance with the
financial responsibility rules will not be
prevented or detected on a timely
basis.104 The proposed definition of
material weakness was modeled on the
definition of material weakness in a
Commission rule—Rule 1–02(a)(4) of
Regulation S–X 105—and in auditing
literature governing financial
reporting.106 In the proposing release,
the Commission stated that a deficiency
in internal control over compliance
would exist when the design or
operation of a control does not allow the
broker-dealer, in the normal course of
performing its assigned functions, to
prevent or detect non-compliance with
the financial responsibility rules on a
timely basis.107 The Commission also
stated that, for purposes of the proposed
definition of the term material
weakness, there is a reasonable
possibility of an event occurring if it is
100 Id.
at 37577.
101 Id.
102 Id.
103 Id.
104 Id.
105 See
17 CFR 210.1–02(a)(4); 17 CFR 240.12b–
2.
106 See PCAOB Auditing Standard, AS No. 5 app.
A at ¶ A7; American Institute of Certified Public
Accountants (‘‘AICPA’’), AU Section 325 at ¶ .06.
107 See Broker-Dealer Reports, 76 FR at 37577.
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51917
probable or reasonably possible.108 The
Commission further stated that an event
is probable if the future event or events
are likely to occur and that an event is
reasonably possible if the chance of the
future event or events occurring is more
than remote, but less than likely.109
ii. Comments Received
The Commission received a number
of comments on the proposed
compliance report. Generally, the
comments focused on the intended
scope of the compliance report and the
assertions to be included. Specifically,
many commenters raised concerns
about what would constitute ‘‘material
non-compliance.’’ 110 Several of these
commenters urged the Commission to
provide guidance with additional
specific examples or quantitative and
qualitative factors to be considered
when determining whether noncompliance was material.111 One
commenter proposed alternate
definitions for material non-compliance
and material weakness and provided
examples of non-compliance that
should not be regarded as material.112
Commenters also addressed the time
period covered by the assertion relating
to effectiveness of internal control. In
particular, some commenters stated that
the proposed assertion that internal
control was effective should be as of a
point in time, as opposed to ‘‘during the
fiscal year.’’ 113 One commenter stated
that broker-dealers that must file the
internal control report required under
108 Id. See also Commission Guidance Regarding
Management’s Report on Internal Control Over
Financial Reporting Under Section 13(a) or 15(d) of
the Securities Exchange Act of 1934, Securities Act
of 1933 Release No. 8810 (June 20, 2007), 72 FR
35324, 35332 n.47 and corresponding text (June 27,
2007).
109 Broker-Dealer Reports, 76 FR at 37577. The
Commission has stated in other contexts that there
is a reasonable possibility of an event occurring if
it is ‘‘probable’’ or ‘‘reasonably possible.’’ See
Amendments to Rules Regarding Management’s
Report on Internal Control Over Financial
Reporting, Exchange Act Release No. 55928 (June
20, 2007), 72 FR 35310 (June 27, 2007). See also 17
CFR 240.12b-2; 17 CFR 210.1–02. Commission
guidance provides that an event is ‘‘probable’’ if the
future event or events are likely to occur, and that
an event is ‘‘reasonably possible’’ if the chance of
the future event or events occurring is more than
remote, but less than likely. See Commission
Guidance Regarding Management’s Report on
Internal Control Over Financial Reporting Under
Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, 72 FR at 35332 n.47 and corresponding
text.
110 See ABA Letter; CAI Letter; CAQ Letter;
Deloitte Letter; E&Y Letter; Grant Thornton Letter;
KPMG Letter; McGladrey Letter; PWC Letter; SIFMA
Letter; Van Kampen/Invesco Letter.
111 See ABA Letter; CAQ Letter; E&Y Letter; KPMG
Letter; McGladrey Letter; PWC Letter.
112 See SIFMA Letter.
113 See Deloitte Letter; E&Y Letter; Grant
Thornton Letter; KPMG Letter.
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Rule 206(4)–2 should be able to elect to
make the assertion pertain to the entire
fiscal year in order to satisfy reporting
requirements under the IA Custody
Rule.114 Others stated that brokerdealers should have the opportunity to
remediate any material weaknesses in
internal control that were identified
during the period and, if corrective
action was taken, not be required to
include them in the compliance
report.115
Regarding the proposed assertion that
the broker-dealer was in compliance
with the financial responsibility rules,
one commenter stated that brokerdealers may need to interpret certain
requirements and in other cases brokerdealers may be relying on informal
interpretations obtained through
dialogue with the Commission or its
DEA.116 This commenter recommended
that in those circumstances the
Commission require broker-dealers to
formally document such interpretations
and obtain evidence of agreements
reached with the Commission or the
DEA.
Some commenters stated that the
Commission should provide additional
guidance about the control objectives
that would need to be met to achieve
effective internal control over
compliance with the financial
responsibility rules.117 Several
commenters urged the Commission to
clarify the interaction between material
weaknesses in internal control over
financial reporting and material
weaknesses in internal control over
compliance with the financial
responsibility rules.118 One commenter
stated that the compliance report was
over-inclusive and burdensome, and
suggested that the final rule focus
instead on ‘‘issues most vital to the
financial condition of the broker-dealer
and its compliance and internal control
over compliance.’’ 119
Some commenters had questions and
comments about the proposed assertion
that information used to assert
compliance with the financial
responsibility rules was derived from
the books and records of the broker114 See E&Y Letter. This commenter also stated
that a point-in-time assessment would be consistent
with the requirement for issuers subject to internal
control reporting under section 404 of the SarbanesOxley Act. Further, for carrying broker-dealers that
are not subject to Rule 206(4)–2, this commenter
stated that the incremental benefits of having the
assertion pertain to the entire year rather than the
year end assessment does not justify the cost. Id.
115 See CAQ Letter; Deloitte Letter; McGladrey
Letter.
116 See E&Y Letter.
117 See Angel Letter; Deloitte Letter.
118 See Deloitte Letter; KPMG Letter; PWC Letter.
119 See CAI Letter.
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dealer. Three commenters asked
whether ‘‘books and records’’ means
records maintained under Rule 17a–
3.120
iii. The Final Rule
The Commission is adopting the
proposed amendments to Rule 17a–5
requiring a carrying broker-dealer to
prepare and file a compliance report,
with modifications, some of which are
in response to comments.121 Generally,
as adopted, the broker-dealer’s
compliance report will include five
specific statements, and two
descriptions, if applicable.
Specifically, paragraph (d)(3) of Rule
17a–5 requires that the compliance
report contain statements as to whether:
(1) The broker-dealer has established
and maintained Internal Control Over
Compliance (which, as discussed below,
is a defined term in the final rule); (2)
the Internal Control Over Compliance of
the broker-dealer was effective during
the most recent fiscal year; (3) the
Internal Control Over Compliance of the
broker-dealer was effective as of the end
of the most recent fiscal year; (4) the
broker-dealer was in compliance with
Rule 15c3–1 and paragraph (e) of Rule
15c3–3 as of the end of the most recent
fiscal year; and (5) the information the
broker-dealer used to state whether it
was in compliance with Rule 15c3–1
and paragraph (e) of Rule 15c3–3 was
derived from the books and records of
the broker-dealer. Further, if applicable,
the compliance report must contain a
description of: (1) Each identified
material weakness in the Internal
Control Over Compliance during the
most recent fiscal year, including those
that were identified as of the end of the
fiscal year; and (2) any instance of noncompliance with Rule 15c3–1 or
paragraph (e) of Rule 15c3–3 as of the
end of the most recent fiscal year.
The final rule does not use the term
assertion—the assertions contained in
the proposal are now referred to as
statements.122 The consistent use of the
term statements is designed to simplify
the structure of the rule rather than to
substantively change the nature of the
matters stated in the compliance report
or which of the statements are to be
examined by the independent public
accountant.
In the final rule, the first statement in
the compliance report is whether the
broker-dealer has established and
maintained Internal Control Over
120 See
CAQ Letter; Deloitte Letter; E&Y Letter.
paragraph (d)(3) of Rule 17a–5.
122 See paragraphs (d)(3)(i)(A)(1)–(5) of Rule 17a–
121 See
5.
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Compliance.123 The rule defines
Internal Control Over Compliance to
mean internal controls that have the
objective of providing the broker-dealer
with reasonable assurance that noncompliance with the financial
responsibility rules will be prevented or
detected on a timely basis.124 In order
to clarify the application of the rule, the
proposal has been modified so that part
of the statement contained in the
proposed compliance report, as to the
broker-dealer’s system of internal
control, has been incorporated in the
definition of Internal Control Over
Compliance in the final rule.125 Under
the final rule, a broker-dealer cannot
state that it has established and
maintained Internal Control Over
Compliance if the internal controls do
not provide the broker-dealer with
reasonable assurance that noncompliance with the financial
responsibility rules will be prevented or
detected on a timely basis.
The final rule also provides that a
broker-dealer is not permitted to
conclude that its Internal Control Over
Compliance was effective if there were
one or more material weaknesses in its
Internal Control Over Compliance.126 A
material weakness is defined as a
deficiency, or a combination of
deficiencies, in the broker-dealer’s
Internal Control Over Compliance such
that there is a reasonable possibility 127
that non-compliance with Rule 15c3–1
or paragraph (e) of Rule 15c3–3 will not
be prevented or detected on a timely
basis, or that non-compliance to a
material extent with Rule 15c3–3,
except for paragraph (e), Rule 17a–13 or
any Account Statement Rule will not be
prevented or detected on a timely
123 See
124 See
paragraph (d)(3)(i)(A)(1) of Rule 17a–5.
paragraph (d)(3)(ii) of Rule 17a–5.
125 Id.
126 See paragraph (d)(3)(iii) of Rule 17a–5. See
also 17 CFR 229.308(a)(3) (providing that
‘‘[m]anagement is not permitted to conclude that
the registrant’s internal control over financial
reporting is effective if there are one or more
material weaknesses in the registrant’s internal
control over financial reporting.’’).
127 As noted above, the Commission has stated in
other contexts that there is a reasonable possibility
of an event occurring if it is ‘‘probable’’ or
‘‘reasonably possible.’’ See Amendments to Rules
Regarding Management’s Report on Internal Control
Over Financial Reporting, 72 FR 35310. See also 17
CFR 240.12b–2; 17 CFR 210.1–02. Commission
guidance provides that an event is ‘‘probable’’ if the
future event or events are likely to occur, and that
an event is ‘‘reasonably possible’’ if the chance of
the future event or events occurring is more than
remote, but less than likely. See Commission
Guidance Regarding Management’s Report on
Internal Control Over Financial Reporting Under
Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, 72 FR at 35332 n.47 and corresponding
text.
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basis.128 A deficiency in Internal
Control Over Compliance exists when
the design or operation of a control does
not allow the management or employees
of the broker-dealer to prevent or detect
on a timely basis non-compliance with
the financial responsibility rules in the
normal course of performing their
assigned functions.
The final amendments reflect several
other key changes from the proposal.
For example, one commenter stated that
the compliance report was overinclusive
and burdensome, and therefore
suggested that the final rule focus on
‘‘issues most vital to the financial
condition of the broker-dealer and its
compliance and internal control over
compliance.’’ 129 The final rule requires
a statement as to whether the brokerdealer was in compliance with Rule
15c3–1 and paragraph (e) of Rule 15c3–
3 as of the end of the most recent fiscal
year and, if applicable, a description of
any instances of non-compliance with
these rules as of the fiscal year end. This
is a modification from the proposed
assertion that the broker-dealer is in
compliance with the financial
responsibility rules in all material
respects and proposed description of
any material non-compliance with the
financial responsibility rules. Thus, the
final rule reflects two changes from the
proposal: (1) Elimination of the
concepts of ‘‘material non-compliance’’
and ‘‘compliance in all material
respects’’ for the purposes of reporting
in the compliance report; and (2) a
narrowing of these statements and
requirements from compliance with all
of the financial responsibility rules to
compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3. In this
way, the final rule more narrowly
focuses on the core requirements of the
financial responsibility rules, as
suggested by the commenter.
The ‘‘material non-compliance’’ and
‘‘compliance in all material respects’’
concepts were designed to limit the
types of instances of non-compliance
that would prevent a carrying brokerdealer from stating that it was in
compliance with the financial
responsibility rules. In order to retain a
limiting principle, the final rule focuses
on provisions that trigger notification
requirements when they are not
128 See paragraph (d)(3)(iii) of Rule 17a–5. See
also 17 CFR 240.12b–2; 17 CFR 210.1–02(a)(4)
(providing that a ‘‘[m]aterial weakness means a
deficiency, or a combination of deficiencies, in
internal controls over financial reporting . . . such
that there is a reasonable possibility that a material
misstatement of the registrant’s annual or interim
financial statements will not be prevented or
detected on a timely basis.’’).
129 See CAI Letter.
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complied with, namely, Rule 15c3–1
and the customer reserve requirement in
paragraph (e) of Rule 15c3–3.130 Any
instance of non-compliance with these
requirements as of the fiscal year end
must be addressed in the compliance
report. As stated in the proposing
release, failing to maintain the required
minimum amount of net capital under
Rule 15c3–1 or failing to maintain the
minimum deposit requirement in a
special reserve bank account under
paragraph (e) of Rule 15c3–3 would
have been instances of material noncompliance under the proposed rule.131
Accordingly, under the proposal, a
broker-dealer would have been required
to describe all instances of noncompliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3. Under the
proposal, a broker-dealer also would
have been required to describe instances
of material non-compliance with Rule
17a–13 and the Account Statement
Rules. The final rule is narrower in that
a broker-dealer is only required to
describe instances of non-compliance
with Rule 15c3–1 and paragraph (e) of
Rule 15c3–3.
Consistent with these changes, the
final rule requires a statement as to
whether the carrying broker-dealer has
established and maintained Internal
Control Over Compliance, which is
defined as internal controls that have
the objective of providing the brokerdealer with reasonable assurance that
non-compliance with the financial
responsibility rules will be prevented or
detected on a timely basis.132 The
definition of Internal Control Over
Compliance modifies the proposed
statement that the carrying broker-dealer
has established and maintained a
system of internal control to provide the
firm with reasonable assurance that any
instances of material non-compliance
with the financial responsibility rules
will be prevented or detected on a
timely basis.133 Thus, the definition
eliminates the concept of material noncompliance. Similarly, the proposed
assertion as to whether the information
used to assert compliance with the
financial responsibility rules was
130 See 17 CFR 240.15c3–1(a)(6)(iv)(B), (a)(6)(v),
(a)(7)(ii), (a)(7)(iii), (c)(2)(x)(B)(1), (c)(2)(x)(F)(3)
(notification requirements with respect to Rule
15c3–1); 17 CFR 240.17a–11(b)–(c) (notification
requirements with respect to Rule 15c3–1); 17 CFR
240.15c3–3(i) (notification requirement in the event
of a failure to make a required deposit to the reserve
account).
131 See Broker-Dealer Reports, 76 FR at 37577.
132 See paragraphs (d)(3)(i)(A)(1) and (d)(3)(ii) of
Rule 17a–5. As indicated above, the independent
public accountant is not required to examine this
statement. See paragraph (g)(2)(i) of Rule 17a–5.
133 See paragraphs (d)(3)(i)(A)(1) and (d)(3)(ii) of
Rule 17a–5.
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derived from the books and records of
the carrying broker-dealer has been
modified to a statement as to whether
the information used to state whether
the carrying broker-dealer was in
compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3 was
derived from the broker-dealer’s books
and records.134
The definition of material weakness
similarly has been modified from the
proposal. Under the final rule, a
material weakness would include
deficiencies in internal control relating
to ‘‘non-compliance’’ with Rule 15c3–1
or paragraph (e) of Rule 15c3–3, and
‘‘non-compliance to a material extent’’
with Rule 15c3–3, except for paragraph
(e), Rule 17a–13, and the Account
Statement Rules.135 This modification of
the definition of material weakness is
based on the practical difficulties in
creating a system of control that will
eliminate a reasonable possibility of the
occurrence of any instances of noncompliance with certain requirements of
the financial responsibility rules. For
example, the inadvertent failure to send
one account statement out of thousands
of such statements would not constitute
non-compliance to a material extent
with the Account Statement Rules
though it would be an instance of noncompliance.
Further, and consistent with current
auditing standards, the definition of
‘‘deficiency in internal control’’ in the
final rule has been modified to include
the phrase ‘‘the management or
employees of the broker or dealer’’ in
place of the phrase ‘‘the broker or
dealer.’’ 136
The final rule—substantially as
proposed—requires the carrying brokerdealer to state whether its Internal
Control Over Compliance was effective
during the most recent fiscal year.137
Some commenters suggested that a
broker-dealer that has remediated a
material weakness be permitted to
provide an assertion about whether a
material weakness still exists at the end
of the year, instead of having to state
whether internal control was effective
during the most recent fiscal year.138 In
light of the importance of a brokerdealer being in continual compliance
134 See
paragraph (d)(3)(i)(A)(5) of Rule 17a–5.
paragraph (d)(3)(iii) of Rule 17a–5.
136 Id. See also PCAOB Auditing Standard, AS
No. 5 app. A, at ¶ A3 (providing that ‘‘[a] deficiency
in internal control over financial reporting exists
when the design or operation of a control does not
allow management or employees, in the normal
course of performing their assigned functions, to
prevent or detect misstatements on a timely
basis.’’).
137 See paragraph (d)(3)(i)(A)(2) of Rule 17a–5.
138 See CAQ Letter; E&Y Letter; KPMG Letter;
PWC Letter.
135 See
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with the financial responsibility rules,
the Commission believes it is
appropriate for the broker-dealer’s
statement to address effectiveness of its
Internal Control Over Compliance
throughout the fiscal year.
Consequently, the final rule requires the
statement to cover the entire fiscal year
as opposed to the date that is the end
of the fiscal year as suggested by
commenters.
However, in response to comments
suggesting that the broker-dealer be
permitted to report the remediation or
whether a material weakness still exists
at the end of the year,139 the final rule
also requires the carrying broker-dealer
to state whether its Internal Control
Over Compliance was effective as of the
end of the most recent fiscal year.140
Thus, if there was a material weakness
in the Internal Control Over Compliance
of the broker-dealer during the year that
has been addressed such that the brokerdealer no longer considers there to be a
material weakness at fiscal year end, the
compliance report would reflect both
the identification of the material
weakness and that its Internal Control
Over Compliance was effective as of the
end of the most recent fiscal year,
thereby indicating that the material
weakness had been addressed as of the
fiscal year end.
Consistent with these changes, the
final rule provides that the carrying
broker-dealer cannot conclude that its
Internal Control Over Compliance was
effective during the most recent fiscal
year if there were one or more material
weaknesses in Internal Control Over
Compliance of the broker-dealer during
the fiscal year.141 The final rule adds a
similar provision relating to the
effectiveness of a broker-dealer’s
Internal Control Over Compliance at the
end of the most recent fiscal year 142 to
respond to comments 143 and to align
with the additional statement discussed
above as to whether the broker-dealer’s
Internal Control Over Compliance was
effective as of the end of the fiscal
year.144
The final rule also retains the
proposed requirement that the carrying
broker-dealer provide a description of
139 See CAQ Letter; Deloitte Letter; E&Y Letter;
McGladrey Letter.
140 See paragraph (d)(3)(i)(A)(3) of Rule 17a–5.
141 See paragraph (d)(3)(iii) of Rule 17a–5. See
also 17 CFR 229.308(a)(3) (providing that
‘‘[m]anagement is not permitted to conclude that
the registrant’s internal control over financial
reporting is effective if there are one or more
material weaknesses in the registrant’s internal
control over financial reporting.’’).
142 See paragraph (d)(3)(iii) of Rule 17a–5.
143 See CAQ Letter; Deloitte Letter; E&Y Letter;
McGladrey Letter.
144 See paragraph (d)(3)(i)(A)(3) of Rule 17a–5.
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each identified material weakness in the
broker-dealer’s Internal Control Over
Compliance, but, in conformity with
other modifications to the proposal, the
final rule requires that the material
weaknesses include those identified
during the most recent fiscal year as
well as those that were identified as of
the end of the fiscal year.145 This change
should not add a significant burden
because broker-dealers should know
whether any material weaknesses
identified before year end have been
remediated.
As noted above, one commenter
recommended that the Commission
require broker-dealers to document oral
guidance obtained through dialogue
with Commission or DEA staff.146 While
such a requirement was not proposed
and is not being adopted in the final
rule, it may be appropriate and prudent
for a broker-dealer to maintain
documentation in its books and records
of the matters discussed with the
Commission or DEA staff, the brokerdealer’s own views and conclusion on
those matters, and any guidance
received by the broker-dealer.
Also as noted above, two commenters
asked the Commission to provide
additional guidance about the control
objectives that should be met to achieve
effective internal control over
compliance with the financial
responsibility rules.147 As stated in the
proposing release, the control objectives
identified in the Commission’s guidance
on Rule 206(4)–2 are more general than
the specific operational requirements in
the financial responsibility rules.148 In
particular, broker-dealers are subject to
operational requirements with respect to
handling and accounting for customer
assets.149 Given the specificity of the
financial responsibility rules, the
Commission does not believe that
additional guidance about the control
objectives is necessary.
As noted above, several commenters
sought assurances that the independent
public accountant’s examination of the
compliance report would not cover the
effectiveness of internal control over
financial reporting.150 The final rule
does not require that the broker-dealer
include a statement regarding the
effectiveness of its internal control over
financial reporting, nor does it require
that the independent public accountant
attest to the effectiveness of internal
control over financial reporting. The
145 See
paragraph (d)(3)(i)(B) of Rule 17a–5.
E&Y Letter.
147 See Angel Letter; Deloitte Letter.
148 See Broker-Dealer Reports, 76 FR at 37580.
149 Id.
150 See Deloitte Letter; KPMG Letter; PWC Letter.
146 See
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requirement in the final rule is for the
broker-dealer to state whether its
Internal Control Over Compliance was
effective during the most recent fiscal
year and at the end of the fiscal year and
for the accountant to express an opinion
based on an examination of those
statements.
A broker-dealer’s Internal Control
Over Compliance is intended to focus,
for example, on a broker-dealer’s
oversight of custody arrangements and
protection of customer assets. In
contrast, internal control over financial
reporting is focused on the reliability of
financial reporting and the preparation
of financial statements in accordance
with GAAP. As stated in the proposing
release, the Commission did not
propose that effectiveness of internal
control over financial reporting be
included as one of the assertions made
by the broker-dealer in the compliance
report. The Commission intends that the
compliance report should focus on
oversight of net capital, custody
arrangements, and protection of
customer assets, and therefore, should
be focused on compliance with the
financial responsibility rules.
Further, the examination of the
compliance report would pertain solely
to certain statements in the compliance
report and not to the broker-dealer’s
process for arriving at the statements.
The report of the independent public
accountant, based on the examination of
the compliance report, requires the
accountant to perform its own
independent examination of the related
internal controls. Consequently, it is not
necessary for the independent public
accountant to provide an opinion with
regard to the process that the brokerdealer used to arrive at its conclusions.
As noted above, commenters sought
clarification of the meaning of ‘‘books
and records’’ as used in the compliance
report statement. The reference in
paragraph (d)(3)(i)(A)(5) of Rule 17a–5
to books and records refers to the books
and records a broker-dealer is required
to make and maintain under
Commission rules (e.g., Rule 17a–3 and
Rule 17a–4).151
4. The Exemption Report—Paragraph
(d)(4) of Rule 17a–5
i. Proposed Amendments
The Commission proposed that the
exemption report must contain an
assertion by the broker-dealer that it is
exempt from Rule 15c3–3 because it
meets conditions set forth in paragraph
(k) of Rule 15c3–3 and ‘‘should identify
151 See
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the specific conditions.’’ 152 As
discussed below in section II.D.3. of this
release, under the proposal, the
independent public accountant, as part
of the engagement, would have been
required to prepare a report based on a
review of the exemption report in
accordance with PCAOB standards.153
ii. Comments Received
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The Commission received several
comments regarding the exemption
report.154 Some commenters stated that
the Commission should clarify whether
the assertion would cover the entire
fiscal year or be as of a fixed date.155
One commenter stated that the assertion
should be as of a fixed date.156 With
respect to the independent public
accountant’s review of the exemption
report, one commenter provided the
example of a bank or clerical error that
results in a broker-dealer that operates
under an exemption to Rule 15c3–3
finding itself in possession of customer
assets overnight once during the fiscal
year.157 This commenter stated that
such a situation should not ‘‘warrant the
‘material modification’ of a brokerdealer’s Exemption Report.’’ 158
Similarly, another commenter noted
that ‘‘to consider a single instance of a
broker-dealer failing to promptly
forward a customer’s securities as an
instance that would necessitate a
material modification creates an
unworkable standard.’’ 159
One commenter stated that the
exemption report relates only to Rule
15c3–3 and asked how the Commission
intended to assess, for a firm that claims
an exemption from Rule 15c3–3,
compliance with Rule 15c3–1 and the
adequacy of the firm’s internal control
over compliance with that rule.160
Another commenter asked whether the
exemption report should be replaced
with a box to check on the FOCUS
Report, as the amount of paperwork
involved for small firms ‘‘seems rather
excessive.’’ 161
152 See Broker-Dealer Reports, 76 FR at 37580–
37581.
153 Id. at 37578–37579. PCAOB standards for
attestation engagements provide that accountants
ordinarily should obtain written assertions in an
examination or review engagement.
154 See CAQ Letter; Deloitte Letter; Grant
Thornton Letter; KPMG Letter. Some of the
comments relating to the exemption report and the
response to the comments are discussed above in
section II.B.1. of this release.
155 See CAQ Letter; Deloitte Letter; Grant
Thornton Letter; KPMG Letter.
156 See KPMG Letter.
157 See SIFMA Letter.
158 Id.
159 See CAI Letter.
160 See McGladrey Letter.
161 See Angel Letter.
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iii. The Final Rule
The Commission is adopting, with
modifications discussed below, the
requirements regarding the exemption
report.162 The modifications are
designed to address commenters’
concerns that the proposed exemption
report assertion would create an
unworkable standard given the
possibility that a broker-dealer might
have instances of exceptions to meeting
the exemption provisions in paragraph
(k) of Rule 15c3–3 and that the proposed
requirements with respect to the
exemption report did not explicitly
provide how exceptions should be
treated. In response to these concerns,
the final rule provides that exemption
reports must contain the following
statements made to the best knowledge
and belief of the broker-dealer: (1) A
statement that identifies the provisions
in paragraph (k) of Rule 15c3–3 under
which the broker-dealer claimed an
exemption from Rule 15c3–3; (2) a
statement the broker-dealer met the
identified exemption provisions in
paragraph (k) of Rule 15c3–3 throughout
the most recent fiscal year without
exception or that it met the identified
exemption provisions in paragraph (k)
of Rule 15c3–3 throughout the most
recent fiscal year except as described in
the exemption report; and (3) if
applicable, a statement that identifies
each exception during the most recent
fiscal year in meeting the identified
provisions in paragraph (k) of Rule
15c3–3 and that briefly describes the
nature of each exception and the
approximate date(s) on which the
exception existed.163
In response to comments seeking
clarity as to whether the assertion in the
exemption report should cover a fixed
date or the fiscal year,164 the final rule
explicitly provides that the statement
and certain information in the
exemption report must cover the most
recent fiscal year.165 This corresponds
to the provisions of paragraph
(d)(1)(i)(B) of Rule 17a–5 governing
when a broker-dealer must file the
exemption report instead of the
compliance report. In particular, a
broker-dealer that claimed an exemption
from Rule 15c3–3 throughout the most
recent fiscal year must file the
exemption report.166
In addition, as proposed, the
exemption report was required to
contain an assertion that the broker162 See
paragraph (d)(4) of Rule 17a–5.
163 Id.
164 See CAQ Letter; Deloitte Letter; Grant
Thornton Letter; KPMG Letter.
165 See paragraph (d)(4)(ii) of Rule 17a–5.
166 See paragraph (d)(1)(i)(B) of Rule 17a–5.
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51921
dealer ‘‘is exempt from the provisions’’
of Rule 15c3–3 ‘‘because it meets
conditions set forth in’’ paragraph (k) of
Rule 15c3–3 and ‘‘should identify the
specific conditions.’’ 167 Thus, the
exemption report would have required
the broker-dealer to state definitively
that ‘‘it is exempt’’ from Rule 15c3–3
because it ‘‘meets the conditions set
forth in’’ in paragraph (k).168 As noted
above, commenters raised questions and
concerns about how certain exceptions
would be handled under the proposed
exemption report requirements. The
final rule addresses these comments in
a number of ways.
First, it provides that the statements
in the exemption report must be made
to the ‘‘best knowledge and belief of the
broker or dealer.’’ 169 This modification
is designed to address situations where
the broker-dealer is unaware of an
instance or instances in which it had an
exception to meeting the exemption
provisions in paragraph (k) of Rule
15c3–3 during the most recent fiscal
year. As discussed below, the brokerdealer must state in the report that it
met the exemption provisions
throughout the year without exceptions
or with exceptions that must be
identified.170
Second, the final rule provides that
the broker-dealer first must identify in
the exemption report the ‘‘provisions’’
in paragraph (k) of Rule 15c3–3 under
which it ‘‘claimed’’ an exemption from
Rule 15c3–3.171 As discussed above in
section II.B.1. of this release, the final
rule has been modified to provide that
a broker-dealer must file the exemption
report if it did ‘‘claim that it was
exempt’’ from Rule 15c3–3 throughout
167 See
Broker-Dealer Reports, 76 FR at 37604.
168 Id.
169 See
paragraph (d)(4) of Rule 17a-5.
discussed above in section II.B.3. of this
release, a carrying broker-dealer must state in the
compliance report whether it was in compliance
with Rule 15c3–1 and paragraph (e) of Rule 15c3–
3 as of the end of the most recent fiscal year. See
paragraph (d)(3)(i)(A)(4) of Rule 17a-5. In response
to comments and in light of the nature of the
statements required in the exemption report, the
Commission added the best knowledge and belief
standard to the exemption report requirement.
171 See paragraph (d)(4)(i) of Rule 17a-5. As
proposed, paragraph (d)(4) of Rule 17a-5 provided
that the exemption report ‘‘shall contain a statement
by the broker or dealer that it is exempt from the
provisions of [Rule 15c3–3] because it meets the
conditions set forth in [paragraph (k) of Rule 15c3–
3] and should identify the specific conditions.’’ See
Broker-Dealer Reports, 76 FR 37604 (emphasis
added). The Commission intended that the brokerdealer be required to identify the provisions of
paragraph (k) of Rule 15c3–3 under which the
broker-dealer was claiming the exemption. To make
clear that this requirement and the other
requirements of the exemption report are
mandatory, the final rule uses the word ‘‘must’’ in
relation to each element of the exemption report.
See paragraph (d)(4) of Rule 17a-5.
170 As
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the most recent fiscal year.172 This
change is designed to remove any
ambiguity as to when a broker-dealer
must file the exemption report as
opposed to the compliance report,
particularly in situations where the
broker-dealer had exceptions to meeting
the exemption provisions in paragraph
(k) of Rule 15c3–3. Consistent with this
change, the final rule requires the
broker-dealer to identify in the
exemption report the provisions in
paragraph (k) under which it ‘‘claimed
the exemption.’’173
Further, as proposed, the brokerdealer would have been required to
identify the exemption ‘‘conditions’’ in
paragraph (k) of Rule 15c3–3.174 The use
of the word ‘‘provisions’’ in the final
rule is designed to eliminate a potential
ambiguity as to whether the exemption
provisions in paragraphs (k)(2) and (3)
of Rule 15c3–3 applied to the exemption
report. In particular, paragraph (k) of
Rule 15c3–3 prescribes ‘‘exemptions’’
from the requirements of Rule 15c3–
3.175 Paragraph (k)(1) provides that the
requirements of Rule 15c3–3 do not
apply to a broker-dealer that meets all
of the ‘‘conditions’’ set forth in the
paragraph.176 Paragraph (k)(2) identifies
two sets of conditions (without using
the word ‘‘conditions’’) either of which
exempts a broker-dealer from the
requirements of Rule 15c3–3.177
Paragraph (k)(3) provides that the
Commission may exempt a brokerdealer from the provisions of Rule 15c3–
3, either unconditionally or on specified
terms and conditions, if the Commission
finds that the broker-dealer has
established safeguards for the protection
of funds and securities of customers
comparable with those provided for by
Rule 15c3–3 and that it is not necessary
in the public interest or for the
protection of investors to subject the
particular broker-dealer to the
provisions of Rule 15c3–3.178 The
Commission intended that a brokerdealer file an exemption report if it is
exempt from Rule 15c3–3 under the
172 See paragraph (d)(1)(i)(B)(2) of Rule 17a-5. A
broker-dealer claiming an exemption from Rule
15c3–3 is required to indicate the basis for the
exemption on the periodic reports it files with
securities regulators. See, e.g., Item 24 of Part IIa of
the FOCUS Reports. See 17 CFR 249.617.
173 See paragraph (d)(4)(i) of Rule 17a-5.
174 See paragraph (d)(4)(ii) of Rule 17a-5. The
proposed rule provided that the broker-dealer must
assert that it is exempt from the provisions of Rule
15c3–3 because it meets ‘‘conditions’’ set forth in
paragraph (k) and should identify the specific
‘‘conditions.’’ See Broker-Dealer Reports, 76 FR at
37580–37581.
175 See 17 CFR 240.15c3–3(k)(1), (k)(2)(i),
(k)(2)(ii), and (k)(3).
176 See 17 CFR 240.15c3–3(k)(1)(i)–(iv).
177 See 17 CFR 240.15c3–3(k)(2)(i)–(ii).
178 See 17 CFR 240.15c3–3(k)(3).
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provisions in either paragraph (k)(1),
(k)(2)(i), (k)(2)(ii), or (k)(3) of Rule 15c3–
3. To make this clear, the final rule
refers to the ‘‘provisions’’ of paragraph
(k) of Rule 15c3–3.179 Consequently, a
broker-dealer filing the exemption
report must identify the provisions in
paragraph (k) that it relied on to claim
an exemption from Rule 15c3–3.180
The third modification designed to
address commenters’ questions and
concerns about how to handle
exceptions to meeting the exemption
provisions in paragraph (k) of Rule
15c3–3 relates to the proposed assertion
that the broker-dealer ‘‘is exempt from
the provisions’’ of Rule 15c3–3 ‘‘because
it meets conditions set forth in’’
paragraph (k). The final rule provides
that the exemption report must contain
a statement that the broker-dealer met
the identified exemption provisions in
paragraph (k) of Rule 15c3–3 throughout
the most recent fiscal year without
exception or that it met the identified
exemption provisions in paragraph (k)
of Rule 15c3–3 throughout the most
recent fiscal year except as described in
the exemption report.181 This
modification from requiring the brokerdealer to state an absolute (i.e., that it is
exempt from Rule 15c3–3) allows the
broker-dealer to account for instances in
which it had exceptions to meeting the
exemption provisions in paragraph (k)
of Rule 15c3–3 directly in the
exemption report (rather than having to
file the compliance report). Specifically,
if to the broker-dealer’s best knowledge
and belief, it had no exceptions during
the most recent fiscal year to the
identified exemption provisions in
paragraph (k) of Rule 15c3–3, it must
state in the exemption report that it met
the identified exemption provisions in
paragraph (k) without exception.
Alternatively, a broker-dealer that had
179 This modification is consistent with Item 24
of Part IIa of the FOCUS Report, which is titled
‘‘EXEMPTIVE PROVISION UNDER RULE 15c3–3’’
and requires a broker-dealer that claims to be
exempt from the requirements of Rule 15c3–3 to
identify the provision in Rule 15c3–3—paragraph
(k)(1), paragraph (k)(2)(i), paragraph (k)(2)(ii), or
paragraph (k)(3)—under which it is claiming to be
exempt. See 17 CFR 249.617.
180 This change also is intended to make clear that
the broker-dealer can identify the provisions of
paragraph (k) of Rule 15c3–3 that the broker-dealer
is relying on to claim the exemption by simply
identifying in the exemption report the
subparagraph in paragraph (k) (i.e., (k)(1), (k)(2)(i),
(k)(2)(ii), or (k)(3)) that contains the particular
conditions the broker-dealer is relying on to claim
the exemption rather than repeating the conditions
themselves in the exemption report. For example,
it would be sufficient for a broker-dealer relying on
the exemption provisions in paragraph (k)(2)(ii) of
Rule 15c3–3 to identify the provisions in the
exemption report under which in claimed an
exemption by referring to ‘‘paragraph (k)(2)(ii) of
Rule 15c3–3’’ or ‘‘17 CFR 240.15c3–3(k)(2)(ii).’’
181 See paragraph (d)(4)(ii) of Rule 17a-5.
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exceptions must state that it met the
identified exemption provisions except
as described in the exemption report.
If the broker-dealer states that it had
exceptions (e.g., exceptions identified
during the year, such as through routine
monitoring of its compliance processes
as part of the execution of its internal
controls, internal or external audits, or
regulatory examinations), the final rule
requires the firm to identify, to its best
knowledge and belief, each exception
and briefly describe the nature of the
exception and the approximate date(s)
on which the exception existed.182 The
Commission expects that non-carrying
broker-dealers generally track
exceptions as part of monitoring
compliance with the exemption
provisions in paragraph (k) of Rule
15c3–3.183 Further, a non-carrying
broker-dealer’s adherence to the
exemption provisions in paragraph (k)
of Rule 15c3–3 generally is a focus of
Commission examiners when they
conduct financial responsibility
examinations on this class of firm. For
example, examiners will review
whether a non-carrying broker-dealer
promptly forwards checks in accordance
with provisions in paragraph (k) of Rule
15c3–3. The Commission also notes that
the 2011 AICPA Broker Dealer Audit
Guide states: ‘‘In auditing the financial
statements of a broker-dealer claiming
exemption from SEC Rule 15c3–3, the
auditor should determine whether and
to what extent the broker-dealer
complied with the specific exemption
during the audit period as well as the
quality of the broker-dealer’s controls
and procedures to ensure ongoing
compliance.’’184 In addition, under the
PCAOB’s proposed standards, the
independent public accountant should
inquire of individuals at the brokerdealer who have relevant knowledge of
controls relevant to the broker-dealer’s
compliance with the exemption
provisions and who are responsible for
monitoring compliance with the
exemption provisions whether they are
aware of any deficiencies in controls
over compliance or instances of noncompliance with the exemption
conditions.185 Moreover, in the
independent public accountant’s report,
‘‘[i]f the broker’s or dealer’s statement is
not fairly stated, in all material respects,
182 See
paragraph (d)(4)(iii) of Rule 15c3–3.
e.g., Net Capital Rule, Exchange Act
Release No. 31511 (Nov. 24, 1992), 57 FR 56973
(Dec. 2, 1992), at 56981 n.25 (stating that noncarrying broker-dealers must develop procedures to
ensure that they do not receive customer securities
or checks made payable to themselves).
184 See AICPA Broker-Dealer Audit Guide at ¶
3.35.
185 See PCAOB Proposing Release app. 2 at ¶ 10.
183 See,
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because of an instance or certain
instances of non-compliance with the
exemption conditions, the auditor must
modify the review report to describe
those instances of non-compliance and
state that the broker or dealer is not in
compliance with the specified
exemption conditions.’’ 186
Under the final rule, a non-carrying
broker-dealer must identify in the
exemption report and describe each
exception during the most recent fiscal
year in meeting the identified
exemption provisions in paragraph (k)
of Rule 15c3–3. The description must
include the approximate date(s) on
which the exception existed. Without
such reporting, the Commission and the
broker-dealer’s DEA would have no
information to assess the nature, extent,
and significance of the exceptions.
As noted above, one commenter asked
whether the exemption report should be
replaced with a box to check on the
FOCUS Report, as the amount of
paperwork involved for small firms
‘‘seems rather excessive.’’ 187 The
Commission does not believe this is an
appropriate alternative. First, as
indicated above, a broker-dealer
claiming an exemption from Rule 15c3–
3 already is required to indicate the
basis for the exemption on its FOCUS
Report.188 Second, the exemption report
requires the broker-dealer to make
certain statements that the independent
public accountant must review. Thus,
the exemption report will provide a
standardized statement across all
broker-dealers claiming an exemption
from Rule 15c3–3 for the independent
public accountant to review. Third, the
exemption report will provide the
Commission and the broker-dealer’s
DEA with more information than
currently is reported by non-carrying
broker-dealers in the FOCUS Report.
Specifically, it requires the brokerdealer to, among other things, state
either that it met the identified
exemption provisions in paragraph (k)
throughout the most recent fiscal year
without exception or that it met the
identified exemption provisions
throughout the most recent fiscal year
except as described in the report. This
will provide the Commission and the
broker-dealer’s DEA with information as
to whether a broker-dealer is meeting
the exemption provisions of paragraph
(k) of Rule 15c3–3 (not simply that the
broker-dealer is claiming the exemption
as is reported in the FOCUS Report).
Fourth, requiring that the exemption
report be filed with the Commission
186 Id.
at ¶ 20.
Angel Letter.
188 See Item 24 of Part IIa of the FOCUS Report.
187 See
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should increase broker-dealers’ focus on
the statements being made, facilitating
consistent compliance with the
exemption provisions in Rule 15c3–3,
and therefore, providing better
protection of customer assets. Fifth, the
requirement to prepare and file the
exemption report should not result in
excessive paperwork, as stated by one
commenter.189
As noted above, one commenter
pointed out that the exemption report
relates solely to Rule 15c3–3 and asked
how the adequacy of a non-carrying
broker-dealer’s internal controls over
compliance with Rule 15c3–1 would be
assessed.190 Under the final
amendments, a broker-dealer’s financial
report will continue to include a
supporting schedule containing a net
capital computation under Rule 15c3–1,
which will be covered by the
independent public accountant’s
examination of the financial report.
Moreover, the PCAOB has proposed
standards for auditing supplemental
information accompanying audited
financial statements.191
5. Time for Filing Annual Reports—
Paragraph (d)(5) of Rule 17a–5
Prior to today’s amendments,
paragraph (d)(5) of Rule 17a–5 required
that the annual audit report be filed not
more than 60 days after the date of the
financial statements.192 The
Commission proposed amending
paragraph (d)(5) to replace the term
annual audit report with annual
reports.193 This change was designed to
reflect the fact that, under the proposal,
broker-dealers must file a financial
report, a compliance report or
exemption report, and reports prepared
by an independent public accountant
covering these reports. While the
Commission did not receive comments
on this proposed change, one
commenter stated that the existing
requirement in Rule 17a–5 that the
annual audit report be filed 60 days
after the date of the financial statements
189 See Angel Letter. The commenter did not
explain why the exemption report would result in
excessive paperwork. Id. See also discussion below
in section VI.D.1.iii. of this release for the estimated
paperwork hour burden associated with this
requirement.
190 See McGladery Letter. The material
inadequacy report—which applied to carrying and
non-carrying broker-dealers—covered Rule 15c3–1.
See 17 CFR 240.17a–5(g).
191 See Proposed Auditing Standard, Auditing
Supplemental Information Accompanying Audited
Financial Statements and Related Amendments to
PCAOB Standards, PCAOB Release No. 2011–05,
PCAOB Rulemaking Docket Matter No. 036 (July 12,
2011) (‘‘PCAOB Proposed Auditing Standard for
Supplemental Information’’).
192 See 17 CFR 240.17a–5(d)(5).
193 See Broker-Dealer Reports, 76 FR at 37604.
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should be lengthened to 90 days.194 In
support of this recommendation, the
commenter cited CFTC Rule 1.10, which
allows an FCM up to 90 days to file
annual audit reports.195
The Commission is adopting, with
modifications, the proposed amendment
to paragraph (d)(5) of Rule 17a–5.196
The modifications add the term
‘‘calendar’’ to make explicit that the
time for filing the annual reports is 60
calendar days after the fiscal year end
(as opposed to business days). The
modifications replace the words ‘‘date
of the financial statements’’ with the
words ‘‘end of the fiscal year of the
broker or dealer’’ to provide consistency
in the language of Rule 17a–5.197 The
final rule does not change the time limit
for filing the annual reports to 90 days
after the end of the fiscal year. The 60day time frame is a long standing
requirement and it provides the
Commission and other regulators with
relatively current information to, among
other things, monitor the financial
condition of broker-dealers. Further,
broker-dealers may seek an extension of
time to file the annual reports from their
DEAs.198
6. Filing of Annual Reports With SIPC—
Paragraph (d)(6) of Rule 17a–5
Prior to today’s amendments,
paragraph (d)(6) of Rule 17a–5 provided
that the ‘‘annual audit report’’ must be
filed at the regional office of the
Commission for the region in which the
broker-dealer has its principal place of
business, the Commission’s principal
office in Washington, DC, and the
principal office of the DEA of the
broker-dealer.199 Copies were required
to be provided to all self-regulatory
organizations (‘‘SROs’’) of which the
broker-dealer is a member.
i. The Proposed Amendments
The Commission proposed two
amendments to this provision. First, the
Commission proposed that an SRO that
is not a broker-dealer’s DEA could by
rule waive the requirement that brokerdealers file annual reports with it
because many SROs do not believe that
it is necessary to receive copies of
broker-dealer annual reports if they are
not the broker-dealer’s DEA.200 The
194 See
IMS Letter.
17 CFR 1.10(b)(ii). Rule 1.10 also provides
that if the FCM is registered with the Commission
as a broker-dealer, the FCM must file the report not
later than the time permitted for filing an annual
audit report under Rule 17a–5.
196 See paragraph (d)(5) of Rule 17a–5.
197 Id. See also paragraph (n) of Rule 17a–5.
198 See paragraph (m) of Rule 17a–5.
199 See 17 CFR 240.17a–5(d)(6).
200 See Broker-Dealer Reports, 76 FR at 37592.
195 See
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Commission received no comments on
this proposal and is adopting it as
proposed.201
Second, the Commission proposed
amending this provision to require a
broker-dealer to file its annual reports
with SIPC.202 SIPC, a nonprofit,
nongovernmental membership
corporation established by SIPA, is
responsible for providing financial
protection to customers of failed brokerdealers. SIPA also provided for the
establishment of a fund (‘‘SIPC Fund’’)
to pay for SIPC’s operations and
activities. SIPC uses the fund to make
advances to satisfy customer claims for
securities and cash that cannot be
readily returned to the customer. SIPA
limits the amount of the advance to
$500,000 per customer, of which
$250,000 can be used to satisfy the cash
portion of a customer’s claim. The SIPC
Fund also covers the administrative
expenses of liquidation proceedings for
failed broker-dealers when the general
estate of the failed firm is insufficient;
these include costs incurred by a
trustee, trustee’s counsel, and other
advisors. SIPC finances the SIPC Fund
through annual assessments, set by
SIPC, on all member firms, plus interest
generated from its permitted
investments. Generally, all brokerdealers registered with the Commission
under section 15(b) of the Exchange
Act 203 are required to be members of
SIPC.204 Before today’s amendments,
broker-dealers were required to file only
limited information with SIPC.
Specifically: (1) Information elicited on
Form SIPC–6, the ‘‘General Assessment
Payment Form;’’ (2) information elicited
on Form SIPC–7, the ‘‘Annual General
Assessment Reconciliation;’’ and (3) for
periods in which the SIPC assessment is
not a minimum assessment, a
comparison by the independent public
accountant of the amounts reflected in
the annual report the broker-dealer filed
with the Commission with amounts
reported on Form SIPC–7.
The Commission explained in the
proposing release that the proposed
requirement for broker-dealers to file
their annual reports with SIPC could
allow SIPC to better monitor industry
trends and enhance its knowledge of
201 See
paragraph (d)(6) of Rule 17a–5.
Broker-Dealer Reports, 76 FR at 37592.
203 See 15 U.S.C. 78o(b).
204 See 15 U.S.C. 78ccc(a)(2). However, brokerdealers engaged exclusively in the distribution of
mutual fund shares, the sale of variable annuities,
the insurance business, the furnishing of
investment advice to investment companies or
insurance company separate accounts, or whose
principal business is conducted outside the U.S. are
not required to be members of SIPC. See 15 U.S.C.
78ccc(a)(2)(A)(i)–(iii).
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202 See
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particular firms.205 The Commission
also explained that the requirement that
broker-dealers file copies of their annual
reports with SIPC was designed to
address cases where the SIPC Fund has
been used to pay the administrative
expenses of the liquidation of a failed
broker-dealer and SIPC sought to
recover the money advanced when the
estate had insufficient assets.206 In some
of these cases, SIPC has sought to
recover money damages from the
broker-dealer’s auditing firm based on
an alleged failure to comply with
auditing standards. At least one court,
however, has held under New York law
that SIPC could not maintain such a
claim because it was not a recipient of
the annual audit filing and could not
have relied on it.207
ii. Comments Received
The Commission received seven
comments on the proposal that brokerdealers be required to file their annual
reports with SIPC.208 Six commenters
generally opposed the requirement.209
One commenter indicated that it is
appropriate for broker-dealers to file
their annual reports with SIPC if SIPC
uses the reports to reconcile the annual
reports with the Form SIPC–7 or
otherwise places reliance on them.210
Three of the commenters stated that the
Commission failed to adequately
articulate the policy considerations
driving the proposed change and also
failed to discuss the possible costs of
increased litigation risk to
accountants.211 Some of the commenters
argued that this change would
contradict limitations on SIPC’s
authority to bring claims against
accountants under SIPA and the
securities laws imposed by the U.S.
Supreme Court.212
After the proposal, a task force
established by SIPC to undertake a
comprehensive review of SIPA and
SIPC’s operations and policies and to
propose reforms to modernize SIPA and
SIPC recommended to the SIPC Board
that SIPC members be required to file
205 See
Broker-Dealer Reports, 76 FR at 37592.
See also SIPC, 2010 Annual Report, at 18,
available at https://www.sipc.org/pdf/
2010%20Annual%20Report.pdf.
207 See SIPC v. BDO Seidman, LLP, 746 NE.2d
1042 (N.Y. 2001).
208 See CAQ Letter; Deloitte Letter; E&Y Letter;
Grant Thornton Letter; KPMG Letter; McGladrey
Letter; PWC Letter.
209 See CAQ Letter; Deloitte Letter; E&Y Letter;
Grant Thornton Letter; KPMG Letter; PWC Letter.
210 See McGladrey Letter. Form SIPC–7 is
discussed in more detail below in section II.C.4. of
this release.
211 See CAQ Letter; Deloitte Letter; KPMG Letter.
212 See CAQ Letter; Deloitte Letter; E&Y Letter;
KPMG Letter; PWC Letter.
206 Id.
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audit reports with SIPC concurrently
with their filing with the SEC, a position
consistent with the proposal. In a report
presented to the SIPC Board of Directors
in February 2012,213 the task force
stated that including SIPC as a
designated recipient of the audit report
‘‘would further the goal of investor
protection by providing another layer of
review of the report by an organization
directly affected by its contents.’’ 214 In
addition, the task force stated that
‘‘including SIPC as a recipient would
help to address the persistent concern
that any signs of ‘financial weakness, as
by non-compliance with net capital
requirements or otherwise, [be] watched
very carefully and followed up’ in order
to augment the financial responsibility
requirements SIPA was intended to
enhance, and to provide greater investor
protection.’’ 215
iii. The Final Rule
The Commission is adopting the
amendment requiring broker-dealers to
file their annual reports with SIPC
substantially as proposed.216 SIPC plays
an important role in the securities
markets and the SIPC Fund can help
reduce losses to investors from the
failure of their broker-dealer. SIPC has
a legitimate interest in receiving the
annual reports of its broker-dealer
members to assist it with its
maintenance of the SIPC Fund and to
monitor trends in the broker-dealer
industry. SIPC presently obtains
revenue information from brokerdealers, through Form SIPC–7, to
determine how best to structure brokerdealer assessments to maintain the SIPC
Fund at an appropriate level. However,
the information collected in the form is
limited and may not assist SIPC in
assessing whether the SIPC Fund is
appropriately sized to the risks of a large
broker-dealer failure. The annual
audited reports contain much more
detailed information about the assets,
liabilities, income, net capital, and Rule
213 See Report and Recommendations of the SIPC
Modernization Task Force (Feb. 2012), available at
https://www.sipc.org/pdf/
Final%Report%202012.pdf. The Task Force was
comprised of volunteers, and included investor
advocates, regulatory specialists, and academic
experts, including the trustee for the liquidation of
Lehman Brothers Inc. and MF Global Inc.
214 See Report and Recommendations of the SIPC
Modernization Task Force, at 19.
215 Id. (quoting the SEC, Study of Unsafe and
Unsound Practices of Broker-Dealers, H.R. Doc. No.
92–231, at 152 (1971)).
216 See paragraph (d)(6) of Rule 17a–5. The
Commission clarified that the broker-dealer must
file the annual reports with SIPC only ‘‘if the broker
or dealer is a member of SIPC.’’ The Commission
believes that SIPC has an interest in receiving
annual reports only from broker-dealers that are
SIPC members, because only these broker-dealers
may pose a risk to the SIPC Fund.
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15c3–3 customer reserve requirements
of broker-dealers, and also include, for
carrying broker-dealers, a compliance
report containing information about the
broker-dealer’s compliance with, and
controls over compliance with, the
broker-dealer financial responsibility
rules. The annual reports also generally
include the independent public
accountant’s reports covering the
financial report and compliance report
or exemption report, as applicable,
prepared by the broker-dealer. This
information will assist SIPC in
monitoring the financial strength of
broker-dealers and, therefore, in
assessing the adequacy of the SIPC
Fund.217
In addition, by receiving the annual
reports, SIPC may be able to overcome
a legal hurdle to pursuing claims against
a broker-dealer’s accountant where the
accountant’s failure to adhere to
professional standards in auditing a
broker-dealer caused a loss to the SIPC
Fund. Although this amendment is
intended to remove one potential legal
hurdle to SIPC actions against
accountants, the other elements of any
relevant cause of action would be
unaffected. The Commission does not
intend by this amendment to take a
position on the circumstances under
which SIPC may have a viable cause of
action against an independent public
accountant.218
Several commenters stated that the
Commission did not address the
potential costs and benefits of requiring
broker-dealers to file copies of their
annual reports with SIPC, including
217 See
McGladrey Letter.
commenters argue that requiring the
annual report to be filed with SIPC would
contradict limitations the Supreme Court has
imposed on SIPC’s authority to bring claims against
accountants. The decisions cited by these
commenters, however, do not speak to the precise
issue the amended rule is intended, among other
things, to address—the New York Court of Appeals’
decision held that SIPC could not state a cause of
action for either fraudulent or negligent
misrepresentation against an auditing firm because
it was not a recipient of the annual audit report. See
SIPC v. BDO Seidman, LLP, 746 NE.2d 1042 (N.Y.
2001); aff’d, 245 F.3d 174 (2d Cir. 2001). Rather, in
Holmes v. Securities Investor Protection
Corporation, the Supreme Court found that the
statutory provision relied on by SIPC, 15 U.S.C.
78eee(d), did not, either alone or with the Racketeer
Influenced and Corrupt Organizations Act, confer
standing. 503 U.S. 258, 275 (1992). And, in Touche
Ross & Co. v. Redington, the Supreme Court
determined that customers of securities brokerage
firms do not have an implied cause of action for
damages under section 17(a) of the Exchange Act
against accountants who audit the financial reports
filed by such firms; thus, SIPC could not assert this
implied cause of action on behalf of these
customers. 442 U.S. 560, 567 (1979). As already
noted, the Commission does not intend by this
amendment to take a position on the circumstances
under which SIPC may have a viable cause of action
against an independent public accountant.
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potential accounting litigation costs.219
As discussed below in section VII. of
this release, the Commission recognizes
that there may be increased litigation
costs (or reserves for potential litigation
costs) as a result of the amendment and
that to the extent that there are such
costs, some of them may be passed on
to broker-dealers in the form of
increased audit fees. But, while this
amendment may facilitate the ability of
SIPC to bring actions against
accountants for malpractice or material
misrepresentation under state law by
removing one potential legal hurdle to
such actions, it will not necessarily
result in a significant increase in such
actions. Generally, SIPC initiates a small
number of proceedings each year, and
most of these proceedings have not
involved a claim against a brokerdealer’s accountant. Specifically, SIPC
was established in 1971. In the period
from 1971–2011, SIPC initiated 324
proceedings under SIPA to liquidate a
failed broker-dealer.220 This results in
an average of approximately 8 SIPA
proceedings per year, though 109 of the
324 proceedings were initiated in the
period from 1971–1974, which was the
immediate aftermath of the financial
crisis of 1968–1970.221 According to
SIPC staff, SIPC has brought 9 lawsuits
against accountants since 1971, which is
one lawsuit for every 36 SIPA
proceedings.222 Accordingly, the
likelihood of a lawsuit against an
accountant is small and the Commission
anticipates that the overall costs related
to litigation as a result of the filing
requirement should not be significant.
The Commission believes that any such
costs are justified by the benefits of
enhanced customer protection and the
associated ability of SIPC to better
assess the financial condition of broker219 See, e.g., CAQ Letter; Deloitte Letter; KPMG
Letter.
220 See SIPC, Annual Report 2011, at 6.
221 Id. See also Commission, Study of Unsafe and
Unsound Practices of Brokers and Dealers: Report
and Recommendations of the Securities and
Exchange Commission (December 1971) (discussing
the financial crisis of 1968–1970). Since its
inception through 2001, SIPC initiated 299
proceedings under SIPA.
222 See Redington v. Touche Ross & Co., 592 F.2d
617 (2d Cir. 1978); In re Bell & Beckwith, 77 B.R.
606 (Bkrtcy. N.D. Ohio, 1987); Mishkin v. Peat,
Marwick, Mitchell & Co., 658 F.Supp. 271 (S.D.N.Y.
1987); SIPC v. BDO Seidman, LLP, 49 F.Supp.2d
644 (S.D.N.Y. 1999); In re Donahue Securities Inc.,
2004 WL 3152763 (Bkrtcy S.D. Ohio, 2004); In re
SIPC v. R.D. Kushnir & Co, 274 B.R. 768 (Bkrtcy.
N.D. Ill., 2002); In re Sunpoint Securities, Inc., 377
B.R. 513 (Bkrtcy. E.D. Tex., 2007); Compliant at 5–
6, Gilbert v. Ohab, Bkrtcy. M.D. Fl. (May 2010) (No.
6:08-ap-00145–KSJ); Complaint at 2, Shively v.
Mortland, Bkrtcy. D. Co. (Feb. 2004) (No. 03–BK–
1102–HRT).
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51925
dealers and the adequacy of the SIPC
Fund.
C. The Nature and Form of the Annual
Reports
1. Exemptions From Audit
Requirement—Paragraph (e)(1) of Rule
17a–5
Prior to today’s amendments,
paragraph (e)(1)(i) of Rule 17a–5
provided, among other things, that the
audit of the broker-dealer’s financial
statements needed to be performed by
an accountant that is independent as
defined in paragraph (f) of Rule 17a–
5.223 Paragraph (e)(1)(i) also contained
provisions under which certain brokerdealers were not required to engage an
accountant to audit their financial
statements.224
The Commission proposed amending
paragraph (e)(1)(i) of Rule 17a–5 to
remove the words ‘‘An audit shall be
conducted by a public accountant who
shall be in fact independent as defined
in paragraph (f)(3) of this section herein,
and he shall give an opinion covering
the statements filed pursuant to
paragraph (d).’’ This amendment would
consolidate the requirements with
respect to the qualifications of the
accountant in paragraph (f) of Rule 17a–
5, and paragraph (e)(1)(i) of Rule 17a–
5 would address only exemptions from
the requirement to engage an
independent public accountant to audit
the annual reports prepared by the
broker-dealer.225 The Commission
received no comments on this proposal,
and is adopting it with modifications.226
The modifications: (1) Modernize
certain terms in the rule in a manner
consistent with the Commission’s
‘‘plain English’’ initiative; and (2) cite to
the reports required under ‘‘Rule 17a–
5(d)(1)(i)(C)’’ to provide a more precise
cross reference than the former citation
to reports required under ‘‘Rule 17a–
5(d).’’ 227
223 See
17 CFR 240.17a–5(e)(1)(i).
224 Id.
225 See Broker-Dealer Reports, 76 FR at 37593–
37594. The proposed and final amendments to
paragraph (f) of Rule 17a–5 are discussed below in
section II.E. of this release.
226 See paragraph (e)(1)(i) of Rule 17a–5.
227 Id. Prior to today’s amendments, paragraph
(e)(1)(ii) of Rule 17a–5 provided that ‘‘[a] broker or
dealer who files a report which is not covered by
an accountant’s opinion shall include in the oath
or affirmation required by paragraph (e)(2) of this
section a statement of the facts and circumstances
relied upon as a basis for exemption from the
requirement that financial statements and schedules
filed pursuant to paragraph (d) of this section be
covered by the opinion of an accountant.’’ See 17
CFR 240.17a–5(e)(1)(ii). The Commission did not
propose amendments to this subparagraph.
However, to be consistent with today’s
amendments, the Commission is making technical
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2. Affirmation—Paragraph (e)(2) of Rule
17a–5
Prior to today’s amendments,
paragraph (e)(2) of Rule 17a–5 provided
that an oath or affirmation must be
attached to the annual audit report that,
to the best knowledge and belief of the
person making the oath or affirmation,
the financial statements and schedules
are true and correct and, among other
things, that the oath or affirmation must
be made by the proprietor if a sole
proprietorship, by a general partner, if a
partnership, or by a duly authorized
officer, if a corporation.228 The
Commission proposed amending the
first sentence of paragraph (e)(2) of Rule
17a–5 by adding the word ‘‘financial’’
before the word ‘‘report.’’229 The
Commission is adopting this
amendment as proposed.
One commenter stated that currently
paragraph (e)(2) of Rule 17a–5 does not
specifically cover limited liability
companies, and its reference to
partnerships assumes that a general
partner is a natural person.230 The
commenter argued that it should be
updated to conform to generally
accepted business laws.
In response to this comment, the
Commission is adopting amendments to
paragraph (e)(2) of Rule 17a–5 that
modify the proposed amendments.231 In
particular, the Commission is adding
that if the broker-dealer is a limited
liability company or limited liability
partnership, the oath or affirmation
must be made by the chief executive
officer, chief financial officer, manager,
managing member, or any of those
members vested with management
authority for the limited liability
company or limited liability
partnership.232
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3. Confidentiality of Annual Reports—
Paragraph (e)(3) of Rule 17a–5
Prior to today’s amendments,
paragraph (e)(3) of Rule 17a–5 provided
that the financial statements filed under
paragraph (d) are public, except that if
the Statement of Financial Condition is
amendments to paragraph (e)(1)(ii) of Rule 17a–5 so
that it now provides that ‘‘[a] broker or dealer that
files annual reports under paragraph (d) of this
section that are not covered by reports prepared by
an independent public accountant must include in
the oath or affirmation required by paragraph (e)(2)
of this section a statement of the facts and
circumstances relied upon as a basis for exemption
from the requirement that the annual reports filed
under paragraph (d) of this section be covered by
reports prepared by an independent public
accountant.’’ See paragraph (e)(1)(ii) of Rule 17a–5.
228 See 17 CFR 240.17a–5(e)(2).
229 See Broker-Dealer Reports, 76 FR at 37603.
230 See IMS Letter.
231 See paragraph (e)(2) of Rule 17a–5.
232 See IMS Letter.
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bound separately from the balance of
the annual audited financial statements
filed under paragraph (d)(1), the balance
of the annual audited financial
statements will be deemed
confidential.233 As noted in the
proposing release, the wording of this
provision has led to confusion.234 In
particular, Commission staff has
received inquiries on how brokerdealers can indicate that they are
requesting confidential treatment for the
portion of the financial statements
intended to be kept confidential to the
extent permitted by law and, on
occasion, financial statements brokerdealers intended to be confidential are
inadvertently made public.235 This
could happen, for example, if a brokerdealer fails to bind the balance sheet
separately from the other portion of the
financial statements when it files the
financial statements with the
Commission.236
Consequently, the Commission
proposed amending paragraph (e)(3) of
Rule 17a–5 to provide that the annual
reports filed pursuant to paragraph (d)
are public, except that if the Statement
of Financial Condition is bound
separately from the annual report filed
pursuant to ‘‘paragraph (d)(2) of Rule
17a–5,’’ and each page of the balance of
the annual report is stamped
‘‘confidential,’’ the balance of the
annual report shall be deemed
confidential.237 The proposed rule text
inadvertently referenced only the
financial report. It was intended that the
financial report, compliance report,
exemption report, and related
accountant reports would be treated the
same under paragraph (e)(3) of Rule
17a–5. Consequently, the Commission is
modifying the proposed amendment.
Specifically, paragraph (e)(3) of Rule
17a–5, as adopted, provides that if the
Statement of Financial Condition is
bound separately from the balance of
the ‘‘annual reports filed under
paragraph (d) of this section,’’ and each
page of the balance of the annual reports
is stamped ‘‘confidential,’’ then the
balance of the annual reports will be
233 See
234 See
17 CFR 240.17a–5(e)(3).
Broker-Dealer Reports, 76 FR at 37592–
37593.
235 The public portions of broker-dealer annual
audited reports are available on the Commission’s
Web site. These reports may be accessed via the
Search for Company Filings link under Filings &
Forms on the Commission’s home page.
236 The Commission staff has previously posted
guidance on the Commission Web site on how to
request confidential treatment for the financial
statements other than the statement of financial
condition. See https://www.sec.gov/divisions/
marketreg/bdnotices.htm.
237 See Broker-Dealer Reports, 76 FR at 37592–
37593.
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deemed confidential to the extent
permitted by law.238 Consequently, if
the compliance reports and exemption
reports and the related reports of the
independent public accountant are
submitted in accordance with the
procedures specified in paragraph (e)(3)
of Rule 17a–5, these reports will be
deemed confidential to the extent
permitted by law.239
Prior to today’s amendments,
paragraph (e)(3) of Rule 17a–5 also
provided that the broker-dealer’s
reports, including the confidential
portions, will be available, for example,
for official use by any official or
employee of the U.S. and an official or
employee of any national securities
exchange and registered national
securities association of which the
broker-dealer is a member and ‘‘by any
other person to whom the Commission
authorizes disclosure of such
information as being in the public
interest.’’ 240 The Commission proposed
amending this list of permitted
recipients to include the PCAOB.241 The
Commission did not receive comments
on this proposal and is adopting it
essentially as proposed with a minor
wording edit for clarity.242
4. Supplemental Report on SIPC
Membership—Paragraph (e)(4) of Rule
17a–5
As discussed above in section II.B.6.
of this release, SIPC maintains the SIPC
Fund to be used in liquidations of
broker-dealers under SIPA. The SIPC
Fund is established and maintained
through assessments on broker-dealers
that are required to be members of
238 See
paragraph (e)(3) of Rule 17a–5.
5 U.S.C. 552 et seq. (Freedom of
Information Act—‘‘FOIA’’). FOIA provides at least
two potentially pertinent exemptions under which
the Commission has authority to withhold certain
information. FOIA Exemption 4 provides an
exemption for ‘‘trade secrets and commercial or
financial information obtained from a person and
privileged or confidential.’’ 5 U.S.C. 552(b)(4). FOIA
Exemption 8 provides an exemption for matters that
are ‘‘contained in or related to examination,
operating, or condition reports prepared by, on
behalf of, or for the use of an agency responsible
for the regulation or supervision of financial
institutions.’’ 5 U.S.C. 552(b)(8). However, as
discussed below, under paragraph (c)(2)(iv) of Rule
17a–5, if there are material weaknesses, the
accountant’s report on the compliance report must
be made available for customers’ inspection and,
consequently, it would not be deemed confidential.
In addition, paragraph (c)(2)(i) of Rule 17a–5 (which
is not being amended today) requires a brokerdealer to furnish to its customers annually a balance
sheet with appropriate notes prepared in
accordance with GAAP and which must be audited
if the broker-dealer is required to file audited
financial statements with the Commission. See 17
CFR 240.17a–5(c)(2)(i).
240 See 17 CFR 240.17a–5(e)(3).
241 See Broker-Dealer Reports, 76 FR at 37592–
37593.
242 See paragraph (e)(3) of Rule 17a–5.
239 See
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SIPC.243 In order to assist in the
collection of assessments from member
broker-dealers, SIPC has promulgated
two forms that broker-dealers must file
with SIPC, as applicable: Form SIPC–3
and Form SIPC–7. Form SIPC–3 is
required when a broker-dealer is
claiming an exemption from SIPC
membership (i.e., when the brokerdealer does not have to pay an
assessment). In this case, the brokerdealer must file Form SIPC–3 each year
certifying that the broker-dealer
remained qualified for the exemption
during the prior year. Form SIPC–7
elicits information from a broker-dealer
that is a SIPC member about the brokerdealer’s sources of revenue attributable
to its securities business. Every brokerdealer that is a member of SIPC must
file this form annually.
Prior to today’s amendments,
paragraph (e)(4) of Rule 17a–5 provided
that a broker-dealer must file with its
annual report a supplemental report on
the status of the membership of the
broker-dealer in SIPC, which was
required to be ‘‘covered by an opinion
of the independent public accountant’’
if the annual report of the broker-dealer
was required to be audited.244 Among
other things, the supplemental report
needed to cover the SIPC annual general
assessment reconciliation or exclusion
from membership forms (i.e., Form
SIPC–7 or Form SIPC–3).245 Paragraph
(e)(4)(iii) of Rule 17a–5 used the terms
‘‘review’’ and ‘‘opinion’’ in describing
the accountant’s report that must cover
the supplement report.246 In addition, it
required that the review by the
accountant include certain minimum
procedures.247
Under this provision, the
supplemental report did not need to be
filed if the SIPC Fund assessments were
the minimum assessment provided for
under SIPA.248 Between 1996 and 2009,
the annual assessment for SIPC
members remained at the $150
minimum assessment level provided for
under SIPA.249 In 2009, SIPC raised the
assessment above the minimum, which
243 Broker-dealers engaged exclusively in the
distribution of mutual fund shares, the sale of
variable annuities, the insurance business, the
furnishing of investment advice to investment
companies or insurance company separate
accounts, or whose principal business is conducted
outside the U.S. are not required to be members of
SIPC. See 15 U.S.C. 78ccc(a)(2)(A)(i)–(iii).
244 See 17 CFR 240.17a–5(e)(4).
245 Id.
246 See 17 CFR 240.17a–5(e)(4)(iii).
247 See 17 CFR 240.17a–5(e)(4)(iii)(A)–(F).
248 See 17 CFR 240.17a–5(e)(4); 15 U.S.C.
78ddd(d)(1)(c).
249 See SIPC, SIPC to Reinstitute Assessments of
Member Firms’ Operating Revenues (Mar. 2, 2009)
(news release).
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triggered the requirement in paragraph
(e)(4) of Rule 17a–5 to file a
supplemental report with the
Commission, the broker-dealer’s DEA,
and SIPC.250
The Commission stated in the
proposing release that, because Forms
SIPC–3 and SIPC–7 are used solely by
SIPC for purposes of levying its
assessments, the supplemental report
required pursuant to paragraph (e)(4) of
Rule 17a–5 relating to these forms
would be more appropriately filed
exclusively with SIPC and that SIPC
(rather than the Commission) should
prescribe by rule the form of the
supplemental report.251 The
Commission stated that it would
continue to have a role in establishing
the requirements for a supplemental
report because the Commission must
approve SIPC rules.252
For these reasons, the Commission
proposed to amend paragraph (e)(4) of
Rule 17a–5 to require that brokerdealers file with SIPC a report on the
SIPC annual general assessment
reconciliation or exclusion from
membership forms that contains such
information and is in such format as
determined by SIPC by rule and
approved by the Commission.253
However, because there would be an
interim period before a rule determined
by SIPC became effective, the
Commission proposed amendments to
paragraph (e)(4) under which brokerdealers would continue to file a
supplemental report with the
Commission, the broker-dealer’s DEA,
and SIPC until SIPC adopts a rule
pursuant to paragraph (e)(4)(i) of Rule
17a–5 and the rule is approved by the
Commission.254 Consequently, a brokerdealer would be required to file the
SIPC supplemental reports with SIPC
using the existing formats for the reports
until the earlier of the Commission
approving a rule adopted by SIPC or two
years. If after two years, a rule
promulgated by SIPC has not been
approved by the Commission, brokerdealers would no longer be required to
file these reports.
Further, to facilitate this change, the
Commission proposed to update the
rule text to conform it to existing
professional standards and industry
practices.255 Specifically, the
Commission proposed amending
paragraph (e)(4) of Rule 17a–5 to
eliminate the ambiguity that stems from
250 Id.
251 See
Broker-Dealer Reports, 76 FR at 37582.
252 Id.
253 Id.
254 Id.
255 Id.
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the differing auditing terms used in that
rule by removing all references to
‘‘review’’ and ‘‘opinion.’’ 256 In their
place, the Commission proposed that
the supplemental report include an
independent public accountant’s report
based on the performance of the
procedures listed in paragraph (e)(4)(iii)
of Rule 17a–5, which the Commission
did not propose to change.257
The Commission received two
comments relating to the proposed
amendments to paragraph (e)(4) of Rule
17a–5, both of which supported the
proposed change.258 One commenter
indicated that the proposed amendment
would decrease the burden on brokerdealers associated with filing the
supplemental report with the
Commission and the broker-dealer’s
DEA.259 In addition, the other
commenter indicated that until the
supplemental reports are filed
exclusively with SIPC, they should be
subject to confidential treatment.260
The Commission is adopting the
amendments to paragraph (e)(4) of Rule
17a–5 as proposed.261 With respect to
the comment about the Commission
keeping the supplemental report
confidential, a broker-dealer can request
confidential treatment for the report.262
If such a request is made, the
Commission anticipates that it will
accord the supplemental report
confidential treatment to the extent
permitted by law.263
256 Id.
257 See Broker-Dealer Reports, 76 FR at 37582.
The Commission proposed one modification to the
procedures listed in former paragraph (e)(4)(iii);
namely, amending the procedure described in
paragraph (e)(4)(iii)(F), which is now renumbered
(e)(4)(ii)(6), to change the reference from ‘‘Form
SIPC–7’’ to ‘‘Form SIPC–3’’ because the reference to
Form SIPC–7 is inaccurate. Id.
258 See CAI Letter; McGladrey Letter.
259 See CAI Letter.
260 See McGladrey Letter.
261 See paragraph (e)(4) of Rule 17a–5.
262 See 17 CFR 200.83. Information about how to
request confidential treatment of information
submitted to the Commission is available at https://
www.sec.gov/foia/howfo2.htm#privacy.
263 See, e.g., Exchange Act section 24, 15 U.S.C.
78x (governing the public availability of
information obtained by the Commission) and 5
U.S.C. 552 et seq. (Freedom of Information Act—
‘‘FOIA’’). FOIA provides at least two pertinent
exemptions under which the Commission has
authority to withhold certain information. FOIA
Exemption 4 provides an exemption for ‘‘trade
secrets and commercial or financial information
obtained from a person and privileged or
confidential.’’ 5 U.S.C. 552(b)(4). FOIA Exemption
8 provides an exemption for matters that are
‘‘contained in or related to examination, operating,
or condition reports prepared by, on behalf of, or
for the use of an agency responsible for the
regulation or supervision of financial institutions.’’
5 U.S.C. 552(b)(8).
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D. Engagement of the Accountant
As part of today’s amendments to the
broker-dealer annual reporting
requirements in Rule 17a–5, the
Commission is amending certain
requirements relating to a brokerdealer’s engagement of an independent
public accountant. Specifically, the
Commission is requiring that a brokerdealer engage an independent public
accountant to prepare reports based on
an examination of the broker-dealer’s
financial report and either an
examination of certain statements in the
broker-dealer’s compliance report or a
review of certain statements in the
broker-dealer’s exemption report. The
examinations and reviews must be made
in accordance with the standards of the
PCAOB, consistent with the explicit
authority granted to the PCAOB by the
Dodd-Frank Act to establish (subject to
Commission approval) auditing and
attestation standards with respect to
broker-dealer audits.264 Among other
things, the amendments replace
provisions that required the filing of a
‘‘material inadequacy’’ report and are
intended to update terminology in the
rule to make the rule’s requirements
clear and to provide for a more
consistent approach to engaging brokerdealer independent public accountants.
This section addresses statutory
requirements for broker-dealer annual
reports and the Commission’s authority
with regard to these reports, describes
the engagement of accountant
requirements in Rule 17a–5 prior to
today’s amendments, summarizes the
Commission’s proposed amendments
and comments received, and discusses
the final rule amendments.
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1. Statutory Requirements and
Commission Authority
Section 17(e)(1)(A) of the Exchange
Act requires a broker-dealer to file
annually with the Commission a
‘‘certified’’ balance sheet and income
statement as well as ‘‘such other
financial statements (which shall, as the
Commission specifies, be certified) and
information concerning its financial
condition as the Commission, by rule,
may prescribe as necessary or
appropriate in the public interest or for
the protection of investors.’’ 265 Section
17(e)(2) of the Exchange Act provides
the Commission with authority, by rule,
to prescribe the form and content of the
financial statements and the accounting
principles and standards used in their
preparation as it deems necessary or
appropriate in the public interest or for
264 See
265 See
Public Law 111–203 § 982.
15 U.S.C. 78q(e)(1)(A).
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the protection of investors.266 In
addition, section 17(a) of the Exchange
Act more generally requires registered
broker-dealers to make and disseminate
such reports as the Commission, by rule,
may prescribe as necessary or
appropriate in the public interest, for
the protection of investors.267 The
Commission adopted Rule 17a–5, in
part, under these provisions.268
Prior to the enactment of the
Sarbanes-Oxley Act of 2002 (‘‘SarbanesOxley Act’’),269 section 17(e)(1)(A)
required that the annual financial
statements a broker-dealer must file
with the Commission be certified by ‘‘an
independent public accountant.’’ The
Sarbanes-Oxley Act established the
PCAOB 270 and amended section
17(e)(1)(A) by replacing the words
‘‘certified by an independent public
accountant’’ with the words ‘‘certified
by a registered public accounting
firm.’’ 271 Title I of the Sarbanes-Oxley
Act prescribed specific PCAOB
registration, standards-setting,
inspection, investigation, disciplinary,
foreign application, oversight, and
funding programs in connection with
audits of issuers.272 However, as
originally enacted, the Sarbanes-Oxley
Act did not expressly prescribe similar
programs in connection with audits of
broker-dealers that are not issuers.
The Dodd-Frank Act, enacted in July
2010, amended the Sarbanes-Oxley Act
to provide the PCAOB with explicit
authority to, among other things,
establish (subject to Commission
approval) auditing and related
attestation, quality control, ethics, and
independence standards for registered
public accounting firms with respect to
their preparation of audit reports to be
included in broker-dealer filings with
the Commission, and the authority to
conduct and require an inspection
program of registered public accounting
firms that audit broker-dealers.273 The
266 See
15 U.S.C. 78q(e)(2).
15 U.S.C. 78q(a).
268 See Broker-Dealer Reports, Exchange Act
Release No. 11935 (Dec. 17, 1975), 40 FR 59706
(Dec. 30, 1975).
269 Public Law 107–204, 116 Stat. 745 (2002).
270 Public Law 107–204 § 101.
271 See Public Law 107–204 § 205(c)(2). The term
Registered Public Accounting Firm is defined in
section 2(a)(12) as ‘‘a public accounting firm
registered with the [PCAOB] in accordance with
this Act.’’ See Public Law 107–204 § 2(a)(12).
272 Section 2(a)(7) of the Sarbanes-Oxley Act
defines the term issuer as ‘‘an issuer as defined in
section 3 of the [Exchange Act], the securities of
which are registered under section 12 of [the
Exchange Act], or that files or has filed a
registration statement that has not yet become
effective under the Securities Act of 1933…, and
that it has not withdrawn’’ (U.S.C. citations
omitted). See Public Law 107–204 § 2(a)(7).
273 See Public Law 111–203 § 982.
267 See
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Dodd-Frank Act addressed inspection
authority by adding section 104(a)(2)(A)
to the Sarbanes-Oxley Act, which
provides that the PCAOB ‘‘may, by rule,
conduct and require a program of
inspection* * *of registered public
accounting firms that provide one or
more audit reports for a broker or
dealer’’ and that the PCAOB, in
establishing a program for inspection,
‘‘may allow for differentiation among
classes of brokers or dealers, as
appropriate.’’ 274
The Dodd-Frank Act also added
section 104(a)(2)(D) to the SarbanesOxley Act, which provides that a public
accounting firm is not required to
register with the PCAOB if the public
accounting firm is exempt from an
inspection program established by the
PCAOB.275 The Dodd-Frank Act made a
conforming amendment to section
17(e)(1)(A) of the Exchange Act to
replace the words ‘‘certified by a
registered public accounting firm’’ with
the words ‘‘certified by an independent
public accounting firm, or by a
registered public accounting firm if the
firm is required to be registered under
the Sarbanes-Oxley Act of 2002.’’ 276
Before today’s amendments,
paragraph (g)(1) of Rule 17a–5 required
that audits of broker-dealer reports filed
with the Commission under Rule 17a–
5 be made in accordance with generally
accepted auditing standards (‘‘GAAS’’),
which are established by the Auditing
Standards Board of the American
Institute of Certified Public Accountants
(‘‘AICPA’’). In light of the authority
granted to the PCAOB by the DoddFrank Act to establish standards
governing audit reports to be included
in broker-dealer filings with the
Commission, the Commission issued
transitional interpretive guidance to
clarify that references in Commission
rules, staff guidance, and in the federal
securities laws to GAAS or to specific
standards under GAAS, as they relate to
non-issuer brokers or dealers, should
continue to be understood to mean
auditing standards generally accepted in
the U.S., in addition to any applicable
rules of the Commission.277 The
274 See
Public Law 111–203 § 982(e)(1).
275 Id.
276 See Public Law 111–203 § 982(e)(2). As
discussed below, today’s amendments to the
qualifications of the independent public accountant
provisions require, consistent with amended
section 17(e)(1)(A), that the accountant be qualified,
independent, and registered with the PCAOB ‘‘if
required by the Sarbanes-Oxley Act of 2002.’’ See
paragraph (f)(1) of Rule 17a–5.
277 See Commission Guidance Regarding
Auditing, Attestation, and Related Professional
Practice Standards Related to Brokers and Dealers,
Exchange Act Release No. 62991 (Sept. 24, 2010),
75 FR 60616, 60617 (Oct. 1, 2010).
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guidance also stated that the
Commission intended to revisit the
interpretation in connection with a
rulemaking project to update the audit
and related attestation requirements
under the federal securities laws for
broker-dealers.278 As discussed below,
the Commission is now adopting
amendments to Rule 17a–5 to require
that audits and attestations of brokerdealer reports filed under Rule 17a–5 be
made in accordance with standards of
the PCAOB—the rule as amended does
not contain references to GAAS.
Since the Commission proposed these
amendments, the PCAOB has taken a
number of actions to implement the
explicit authority over broker-dealer
audits provided to it by the Dodd-Frank
Act. For example, on August 18, 2011,
the Commission approved two PCAOB
rule changes: a temporary PCAOB rule
that established an interim program of
inspection of audits of broker-dealers,279
and a PCAOB rule change providing
that funds to cover the PCAOB’s annual
budget be allocated among issuers,
brokers, and dealers.280 In addition, as
discussed below, subsequent to the
Commission’s proposal to amend Rule
17a–5, the PCAOB proposed attestation
standards to establish requirements for
examining broker-dealer compliance
reports and reviewing broker-dealer
exemption reports ‘‘to align its
attestation standards more closely with
the auditor’s responsibilities under [the
proposed amendments to Rule 17a–
5].’’ 281 The PCAOB concurrently
proposed an auditing standard for
supplemental information
accompanying audited financial
statements that would supersede the
current standard.282 The auditing
standard would apply to supporting
schedules broker-dealers must file
under Rule 17a–5, including schedules
regarding the computation of net capital
and the customer reserve requirement
and information related to the brokerdealer’s possession or control of
customer assets.283 The PCAOB also
proposed amendments ‘‘to tailor certain
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278 Id.
279 See Public Company Accounting Oversight
Board; Order Approving Proposed Temporary Rule
for an Interim Program of Inspection Related to
Audits of Brokers and Dealers, Exchange Act
Release No. 65163 (Aug. 18, 2011), 76 FR 52996
(Aug. 24, 2011).
280 See Public Company Accounting Oversight
Board; Order Approving Proposed Board Funding
Rules for Allocation of the Board’s Accounting
Support Fee Among Issuers, Brokers, and Dealers,
and Other Amendments to the Board’s Funding
Rules, Exchange Act Release No. 65162 (Aug. 18,
2011), 76 FR 52997 (Aug. 24, 2011).
281 See PCAOB Proposing Release at 5.
282 See PCAOB Proposed Auditing Standard for
Supplemental Information.
283 Id. at 3.
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of its rules to the audits and
[independent public accountants] of
broker-dealers.’’ 284
2. Engagement of Accountant
Requirements Prior to Today’s
Amendments
Rule 17a–5 requires that a brokerdealer prepare and file certain financial
statements and supporting schedules in
addition to the balance sheet and
income statement required under
section 17(e)(1)(A) of the Exchange
Act.285 Before today’s amendments, the
financial statements and supporting
schedules were generally required to be
audited in accordance with GAAS by an
independent public accountant
registered with the PCAOB.286
In addition to filing a report of the
independent public accountant covering
the financial statements and supporting
schedules, paragraph (j) of Rule 17a–5
required the broker-dealer to file with
the annual audit a supplemental report
prepared by the accountant (‘‘material
inadequacy report’’) that either: (1)
Indicated that the accountant did not
find any material inadequacies; or (2)
described any material inadequacies in
internal control the accountant found
during the course of the audit of the
financial statements and supporting
schedules and any corrective action
taken or proposed by the brokerdealer.287
284 See Proposed Amendments to Conform the
Board’s Rules and Forms to the Dodd-Frank Act
and Make Certain Updates and Clarifications,
PCAOB Release No. 2012–002, PCAOB Rulemaking
Docket Matter No. 039 (Feb. 28, 2012).
285 See 17 CFR 240.17a–5(d).
286 See 17 CFR 240.17a–5(g). An engagement to
perform an audit (or examination) of financial
statements is designed to provide reasonable
assurance about whether the financial statements
are free of material misstatement. See, e.g., PCAOB
Interim Auditing Standard, AU Section 110 at ¶ .02.
The term audit is defined in section 110(1) of the
Sarbanes-Oxley Act, as amended by the Dodd-Frank
Act, to mean ‘‘an examination of the financial
statements, reports, documents, procedures,
controls, or notices of an issuer, broker, or dealer
by an independent public accountant in accordance
with the rules of the [PCAOB] or the Commission,
for the purpose of expressing an opinion on the
financial statements or providing an audit report.’’
287 See 17 CFR 240.17a–5(j). Prior to today’s
amendments, paragraph (g)(3) of Rule 17a–5
describes a material inadequacy in a broker-dealer’s
accounting system, internal accounting controls,
procedures for safeguarding securities, and
practices and procedures to include any condition
which has contributed substantially to or, if
appropriate corrective action is not taken, could
reasonably be expected to: (1) Inhibit a brokerdealer from promptly completing securities
transactions or promptly discharging its
responsibilities to customers, other broker-dealers
or creditors; (2) result in material financial loss; (3)
result in material misstatements of the brokerdealer’s financial statements; or (4) result in
violations of the Commission’s recordkeeping or
financial responsibility rules to an extent that could
reasonably be expected to result in the conditions
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For purposes of preparing the material
inadequacy report, paragraph (g)(1) of
Rule 17a–5 required that the audit
include a ‘‘review’’ of the brokerdealer’s accounting system, internal
accounting control, and procedures for
safeguarding securities.288 Further, the
accountant was required to review the
practices and procedures of the brokerdealer in: (1) Making the periodic
computations of aggregate indebtedness
and net capital under paragraph (a)(11)
of Exchange Act Rule 17a–3 and the
reserve required by paragraph (e) of
Rule 15c3–3; 289 (2) making the
quarterly securities examinations,
counts, verifications, and comparisons
and the recordation of differences
required by Rule 17a–13; 290 (3)
complying with the requirement for
prompt payment for securities under
Regulation T of the Board of Governors
of the Federal Reserve System
(‘‘Regulation T’’); 291 and (4) obtaining
and maintaining physical possession or
control of all fully paid and excess
margin securities of customers as
required by Rule 15c3–3.292 The scope
of the independent public accountant’s
procedures was required to be sufficient
to provide ‘‘reasonable assurance’’ that
any material inadequacies existing at
the date of the examination in the
broker-dealer’s accounting system,
internal accounting control, and
procedures for safeguarding securities as
well as in the practices and procedures
described in items (1) through (4) above
would be disclosed.293
The AICPA Broker-Dealer Audit
Guide provided that the material
inadequacy report should address what
the independent public accountant
concluded in its ‘‘study’’ of the
adequacy of the broker-dealer’s
described in (1) through (3) above. See 17 CFR
240.17a–5(g)(3). In addition to the material
inadequacy report, a broker-dealer was required to
file during certain periods a supplemental report
covered by an opinion of the independent public
accountant on the status of the broker-dealer’s
membership in SIPC. See 17 CFR 240.17a–5(e)(4).
The Commission is amending this requirement as
discussed above in section II.C.4. of this release.
Further, a broker-dealer that computes net capital
under the alternative model-based standard in
Appendix E to Rule 15c3–1 (17 CFR 240.15c3–1e)
is required to file a supplemental report of an
independent public accountant indicating the
results of the accountant’s review of the internal
risk management control system established and
documented by the broker-dealer in accordance
with Rule 15c3–4 (17 CFR 240.15c3–4). See 17 CFR
240.17a–5(k). The Commission is not amending this
requirement today.
288 See 17 CFR 240.17a–5(g)(1).
289 See 17 CFR 240.17a–5(g)(1)(i).
290 See 17 CFR 240.17a–5(g)(1)(ii).
291 See 17 CFR 240.17a–5(g)(1)(iii). See also 12
CFR 220 et seq. (Regulation T).
292 See 17 CFR 240.17a–5(g)(1)(iv).
293 See 17 CFR 240.17a–5(g)(1).
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practices and procedures in complying
with the financial responsibility rules in
relation to the definition of material
inadequacy as stated in paragraph (g)(3)
of Rule 17a–5.294 The issuance of a
study is relatively unique to brokerdealer audits, however, and while
auditing standards at one time referred
to the performance of a study, current
auditing standards no longer contain
such references.
Additional engagement of accountant
requirements prior to today’s
amendments were set forth in
paragraphs (g) and (i) of Rule 17a–5.
Paragraph (g)(2) of Rule 17a–5 provided
that, if the broker-dealer was exempt
from Rule 15c3–3, the independent
public accountant must ascertain that
the conditions of the exemption were
being complied with as of the
examination date and that no facts came
to the independent public accountant’s
attention to indicate that the exemption
had not been complied with during the
period since the last examination.295
Paragraph (i) of Rule 17a–5, before
today’s amendments, was titled,
‘‘Accountant’s reports—general
provisions.’’ 296 Paragraph (i)(1) of Rule
17a–5 provided that the accountant’s
report must be dated, signed manually,
indicate the city and state where issued,
and identify the financial statements
and schedules covered by the report.297
Paragraph (i)(2) of Rule 17a–5 provided
that the accountant’s report must state
whether the audit was made in
accordance with generally accepted
auditing standards; state whether the
accountant reviewed the procedures
followed for safeguarding securities; and
designate any auditing procedures
294 The material inadequacy report is addressed
in the AICPA’s Audit & Accounting Guide: Brokers
and Dealers in Securities (Sept. 1, 2011 ed.)
(‘‘AICPA Broker-Dealer Audit Guide’’), which
provides that the report should: (1) Address what
auditors concluded in their study of the adequacy
of the broker-dealer’s practices and procedures in
complying with the Commission’s financial
responsibility rules in relation to the definition of
a material inadequacy in Rule 17a–5; and (2)
disclose material weaknesses in internal control
over financial reporting (including procedures for
safeguarding securities) that are revealed through
auditing procedures designed and conducted for the
purpose of expressing an opinion on the financial
statements. See AICPA Broker-Dealer Audit Guide
at ¶ 3.77. The AICPA Broker-Dealer Audit Guide
further provides that if conditions believed to be
material weaknesses are found to exist or have
existed during the year, the report should disclose
the nature of the weaknesses and the corrective
action taken or proposed to be taken by the brokerdealer. See AICPA Broker-Dealer Audit Guide at ¶
3.80. The AICPA Broker-Dealer Audit Guide also
provides sample reports ‘‘on internal control
required by SEC Rule 17a–5(g)(1).’’ See AICPA
Broker-Dealer Audit Guide apps. C, D, and F.
295 See 17 CFR 240.17a–5(g)(2).
296 See 17 CFR 240.17a–5(i).
297 See 17 CFR 240.17a–5(i)(1).
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deemed necessary by the accountant
under the circumstances of the
particular case which have been
omitted, and the reason for their
omission.298 Further, the rule provided
that ‘‘[n]othing in this section shall be
construed to imply authority for the
omission of any procedure which
independent accountants would
ordinarily employ in the course of an
audit made for the purpose of
expressing the opinions required under
[Rule 17a–5].’’ 299
Prior to today’s amendments,
paragraph (i)(3) of Rule 17a–5 provided
that the accountant’s report must state
clearly the opinion of the accountant: (i)
with respect to the financial statements
and schedules covered by the report and
the accounting principles and practices;
and (ii) as to the consistency of the
application of the accounting principles,
or as to any changes in such principles
that have a material effect on the
financial statements.300 Paragraph (i)(4)
provided that any matters to which the
accountant took exception must be
clearly identified, the exception
specifically and clearly stated, and, to
the extent practicable, the effect of each
such exception on the related financial
statements given.301 Paragraph (i)(5) of
Rule 17a–5 provided that the terms
audit (or examination), accountant’s
report, and certified have the meanings
given in Rule 1–02 of Regulation S–X
(17 CFR 210.1–02).302
3. Amended Engagement of Accountant
Requirements
i. Proposed Amendments
The Commission proposed to
substantially amend paragraph (g) and
remove paragraph (j) of Rule 17a–5, in
part, to update the engagement of the
accountant requirements to address
outdated or inconsistent terminology in
the rule.303 The proposed amendments
to paragraph (g) and removal of
paragraph (j) of Rule 17a–5 would have
eliminated the requirement for the
accountant to prepare and the brokerdealer to file a material inadequacy
report.304 In its place, the independent
public accountant would have been
required to prepare, and the brokerdealer would have been required to file,
in addition to a report covering the
298 See
17 CFR 240.17a–5(i)(2).
299 Id.
300 See
17 CFR 240.17a–5(i)(3).
17 CFR 240.17a–5(i)(4).
302 See 17 CFR 240.17a–5(i)(5).
303 See Broker-Dealer Reports, 76 FR at 37578–
37579. In addition, the Commission proposed
changing the title of paragraph (g) from Audit
objectives to Engagement of the independent public
accountant. Id. at 37606.
304 Id. at 37578–37579.
301 See
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financial report, a report covering either
the broker-dealer’s compliance report or
exemption report, as applicable.305
Specifically, the Commission proposed
to amend paragraph (g) of Rule 17a–5 to
be titled ‘‘Engagement of independent
public accountant’’ and to require a
broker-dealer required to file annual
reports under paragraph (d) of Rule 17a–
5 to engage an independent public
accountant, unless the broker-dealer is
subject to the exclusions in paragraphs
(d)(1) and (e)(1)(i) of Rule 17a–5. The
independent public accountant, as part
of the engagement, would have been
required to undertake to: (1) Prepare a
report based on an examination of the
broker-dealer’s financial report in
accordance with standards of the
PCAOB; and (2) prepare a report based
on an ‘‘examination’’ of the assertions of
the broker-dealer in the compliance
report in accordance with standards of
the PCAOB 306 or to prepare a report
based on a ‘‘review’’ of the brokerdealer’s exemption report in accordance
with standards of the PCAOB.307 This
provision would have retained the
requirement that the financial
statements and supporting schedules be
audited by the independent public
accountant, so that the accountant
would have continued to be required to
obtain ‘‘reasonable assurance’’ about
whether they were free of material
misstatement, but would have changed
305 Id.
306 An attest engagement designed to provide a
high level of assurance is referred to as an
‘‘examination.’’ See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ¶ .54. For
this type of engagement, the accountant’s
conclusion will be expressed in the form of an
opinion. For example, the accountant’s conclusion
based on an examination of an assertion could state
that in the accountant’s opinion, [the assertion] is
fairly stated in all material respects. See, e.g.,
PCAOB Interim Attestation Standard, AT Section
101 at ¶ .84. The proposed rule provided that the
examination and related report would apply to the
broker-dealer’s ‘‘assertions’’ in the compliance
report (and therefore would not apply to other items
in the proposed compliance report; namely, a
statement as to whether the broker-dealer has
established a system of internal control and a
description of instances of material noncompliance, and material weaknesses over
compliance with, the financial responsibility rules).
307 An attest engagement designed to provide a
moderate level of assurance is referred to as a
‘‘review.’’ See, e.g., PCAOB Interim Attestation
Standard, AT Section 101 at ¶¶ .55, .89. For this
type of engagement, the accountant’s conclusion
will be expressed, not in the form of an opinion,
but in the form of ‘‘negative assurance.’’ See, e.g.,
PCAOB Interim Attestation Standard, AT Section
101 at ¶ .68. For example, the accountant’s
conclusion based on a review of an assertion could
state that no information came to the accountant’s
attention that indicates that the assertion is not
fairly stated in all material respects. See, e.g.,
PCAOB Interim Attestation Standard, AT Section
101 at ¶ .88.
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the audit standards from GAAS to
standards of the PCAOB.308
The Commission proposed making
conforming amendments to paragraph
(i) of Rule 17a–5, substituting the words
‘‘examinations’’ and ‘‘reviews’’ for the
word ‘‘audits,’’ substituting the words
‘‘standards of the PCAOB’’ for
‘‘generally accepted auditing
standards,’’ substituting ‘‘annual
reports’’ for ‘‘financial statements,’’ and
changing the title to ‘‘Reports prepared
by the independent public accountant.’’
The Commission also proposed deleting
paragraph (i)(5) of Rule 17a–5, which
provided that the terms ‘‘audit,’’
‘‘examination,’’ ‘‘accountant’s report,’’
and ‘‘certified’’ have the meanings given
in Rule 1–02 of Regulation S–X. As
proposed, paragraph (i)(1) of Rule 17a–
5 would have provided that the
independent public accountant’s reports
must: be dated; be signed manually;
indicate the city and state where issued;
and identify without detailed
enumeration the items covered by the
reports. Paragraph (i)(2) of Rule 17a–5
would have provided that the
accountant’s report must state whether
the examination or review was made in
accordance with standards of the
PCAOB and must designate any
examination, and, if applicable, review
procedures deemed necessary by the
independent public accountant under
the circumstances of the particular case
that have been omitted, and the reason
for their omission. Further, the rule
would have provided that ‘‘[n]othing in
this section shall be construed to imply
authority for the omission of any
procedure that independent public
accountants would ordinarily employ in
the course of an examination or review
made for the purpose of expressing the
opinions or statement required under
[Rule 17a–5].’’ Paragraph (i)(3) of Rule
17a–5 would have provided that the
independent public accountant’s reports
must state clearly the opinion of the
independent public accountant: (i) with
respect to the financial report and the
accounting principles and practices
reflected therein and the compliance
report; and (ii) with respect to the
financial report, as to the consistency of
the application of the accounting
principles, or as to any changes in such
principles that have a material effect on
the financial statements. Paragraph (i)(4)
of Rule 17a–5 would have provided that
any matters to which the independent
308 See Broker-Dealer Reports, 76 FR at 37606. As
stated above, an engagement to perform an audit of
financial statements is designed to provide
‘‘reasonable assurance’’ about whether the financial
statements are free of material misstatement. See,
e.g., PCAOB Interim Attestation Standard, AT
Section 101 at ¶ .54.
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public accountant takes exception must
be clearly identified, the exception
thereto specifically and clearly stated,
and, to the extent practicable, the effect
of each such exception on any related
items contained in the annual reports.
As stated above, after the Commission
proposed the amendments to Rule 17a–
5, the PCAOB issued proposed
standards that ‘‘would establish
requirements for examining the
assertions in a broker’s or dealer’s
compliance report and reviewing a
broker’s or dealer’s assertion in the
exemption report.’’ 309 The PCAOB
stated that the proposed standards were
‘‘tailored to the requirements’’ in Rule
17a–5 as proposed to be amended by the
Commission.310
ii. Comments
The Commission received several
comments regarding the proposed
revisions to the independent accountant
engagement requirements in Rule 17a–
5.311 One commenter stated that GAAS
should be used for audits of noncarrying broker-dealers; or, in the
alternative, that the Commission should
delay the effective date for the
requirement that the audit be conducted
in accordance with PCAOB standards
for smaller broker-dealers until one year
after the approval of the
amendments.312 A second commenter
stated that PCAOB standards should
apply only for broker-dealers
‘‘permanently subject to PCAOB
inspection’’ and that the Commission
should not require that audits of brokerdealers be performed in accordance
with PCAOB standards for non-issuer
broker-dealers until the PCAOB
determines which non-issuer brokerdealers will be subject to its permanent
inspection program.313
One commenter noted that the
proposing release states that brokerdealers will be required to file a report
by the accountant that ‘‘addresses’’ the
assertions in the compliance report,314
and stated that the Commission should
provide more guidance on what an
accountant must address, as ‘‘nowhere
in the Release or in the proposed rules
is there guidance as to what ‘addresses’
means or entails.’’ 315 This commenter
further stated that the Commission
309 See
‘‘presumably’’ will rely on PCAOB
rules, and suggested that final rules
regarding the accountant’s obligations
with respect to its examination of the
compliance report should be deferred
until after a comment period of at least
60 days after the PCAOB rules are
finalized or the Commission amends its
proposal to include specifics as to what
‘‘address’’ means and what type of
review is required by the accountant.316
The commenter also stated that the
requirement should not be effective
unless the AICPA Broker-Dealer Audit
Guide is revised and updated.317 One
commenter asked what was expected of
the auditor with respect to the books
and records assertion and stated that a
separate opinion on this assertion may
entail more detailed procedures as to
the source of the information.318
Another commenter stated that a
review engagement should not be
employed for the exemption report
because inquiry and observation would
not provide sufficient evidence
regarding a broker-dealer’s assertion that
it is exempt from the requirements of
Rule 15c3–3 and stated that, under the
PCAOB’s interim attestation standards,
an auditor should not accept an
engagement to perform a ‘‘review’’ level
of service related to an entity’s
compliance with specified requirements
or an assertion with regard to that
compliance.319 As an alternative, this
commenter suggested an ‘‘agreed-upon
procedures’’ approach addressing the
results of procedures specified by the
Commission or the performance of an
examination engagement if suitable
criteria were developed.320 Another
commenter stated that the benefit of
receiving an audit report covering the
exemption report would not justify the
cost.321 Similarly, a commenter stated
that the exemption report should be
replaced with a box to check on the
FOCUS Report as the auditor attestation
provided no added benefit.322
Several commenters urged the
Commission to clarify the interaction
between material weaknesses in internal
control over financial reporting and
material weaknesses in internal control
over compliance with the financial
responsibility rules.323 One commenter
stated that due to the reliance placed on
the financial books and records to
PCAOB Proposing Release at 5.
316 Id.
310 Id.
311 See,
e.g., ABA Letter; AICPA Letter; Citrin
Letter; E&Y Letter; Van Kampen/Invesco Letter.
312 See Citrin Letter. The Commission also
received many comments seeking additional time to
transition to the final rules. Those comments are
discussed below in section V. of this release.
313 See AICPA Letter.
314 See Broker-Dealer Reports, 76 FR at 37575.
315 See ABA Letter.
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317 Id. As stated below, AICPA guidance will no
longer be applicable once standards of the PCAOB
apply to broker-dealer annual reports.
318 See Grant Thornton Letter.
319 See E&Y Letter.
320 Id.
321 See Citrin Letter.
322 See Angel Letter.
323 See Deloitte Letter; KPMG Letter; PWC Letter.
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calculate net capital, it will not be
feasible to attest to the effectiveness of
internal control over the financial
responsibility rules without also
attesting to internal control over
financial reporting.324 The commenter
stated that, accordingly, it is necessary
to include internal control over
financial reporting within the scope of
the rule. The commenter stated its
understanding that accountants expect
to include internal control over
financial reporting in their attestation
scope over the financial responsibility
rules, and that the process will include
documenting all existing processes and
engaging internal audit to validate the
effectiveness of the procedures
implemented through procedural
walkthroughs and control testing to
validate management’s assertions.325
This commenter also stated its belief
that independent public accountants
will need ‘‘to include an attestation of
the additional in scope processes within
the scope of their audit work in order to
comply with PCAOB requirements.’’ 326
As noted above in section II.B.4.ii. of
this release, with respect to the
independent public accountant’s review
of the exemption reports, one
commenter stated that, for example, a
bank or clerical error that results in a
broker-dealer that operates under an
exemption to Rule 15c3–3 finding itself
in possession of customer assets
overnight once during the fiscal year
should not ‘‘warrant the ‘material
modification’ of a broker-dealer’s
Exemption Report.’’ 327 Another
commenter noted that ‘‘to consider a
single instance of a broker-dealer failing
to promptly forward a customer’s
securities as an instance that would
necessitate a material modification
creates an unworkable standard.’’ 328
iii. The Final Rule
The Commission is adopting
amendments to the engagement of the
accountant requirements in Rule 17a–5
substantially as proposed, except for
revisions, as discussed in detail below,
to clarify the rule’s requirements and to
make technical changes. Paragraph (g) of
Rule 17a–5 as adopted provides that the
independent public accountant engaged
by the broker-dealer to provide reports
on the financial report and either the
compliance report or exemption report
must, as part of the engagement
undertake to: (1) Prepare a report based
on an examination of the broker-dealer’s
324 See
Van Kampen/Invesco Letter.
325 Id.
326 Id.
327 See
328 See
SIFMA letter.
CAI Letter.
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financial report in accordance with
standards of the PCAOB; and (2) prepare
a report based on an examination of
certain enumerated statements of the
broker-dealer in the compliance
report 329 in accordance with standards
of the PCAOB or prepare a report based
on a review of the statements in the
broker-dealer’s exemption report in
accordance with standards of the
PCAOB. Additionally, as proposed, the
amendments delete paragraph (j) of Rule
17a–5, which, as explained above,
required that the broker-dealer file with
the annual audit report a material
inadequacy report, as well as provisions
in paragraph (g) of Rule 17a–5 requiring
that the audit be conducted in
accordance with GAAS and addressing
the accountant’s review for material
inadequacies.
Various commenters suggested that
GAAS instead of PCAOB standards
should apply for engagements of
accountants with respect to certain
broker-dealer reports, such as reports of
non-carrying broker-dealers.330 The
Commission believes that requiring
GAAS for audits of broker-dealers that
are exempt from Rule 15c3–3 would not
be consistent with the provisions of the
Dodd-Frank Act that provide the
PCAOB with explicit authority to
establish standards with regard to audits
of broker-dealer reports filed with the
Commission.331 These provisions enable
the PCAOB to exercise its standardsetting authority over audits of brokerdealers registered with the Commission.
The change from GAAS to PCAOB
auditing standards will facilitate the
Commission’s regulatory oversight
authority because the Commission has
direct oversight authority over the
PCAOB, including the ability to approve
or disapprove the PCAOB’s rules and
standards. The Commission also has
329 As discussed above in section II.B.3. of this
release, the final rule does not use the term
assertion—the assertions contained in the proposal
are now referred to as statements. These changes are
not intended to be substantive. Paragraph (g) of
Rule 17a–5 specifies that the accountant prepare a
report based on an examination of certain
statements enumerated in the rule. Similar to the
proposal, the statements subject to the examination
do not include a statement as to whether the brokerdealer has established a system of internal control
or a description of instances of non-compliance
with certain financial responsibility rules.
330 See AICPA Letter; Citrin Letter.
331 See Public Law 111–203 § 982. For example,
section 982(a) of the Dodd-Frank Act added section
110 to the Sarbanes-Oxley Act, which contains
definitions of terms such as audit, audit report, and
professional standards. These definitions apply to
audits, audit reports, and professional standards
with respect to audits of broker-dealers as well as
audits of issuers. In addition, section 982(b) of the
Dodd-Frank Act amended section 101 of the
Sarbanes-Oxley Act to substitute the words
‘‘issuers, brokers, and dealers’’ for the word
‘‘issuers.’’
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greater confidence in the quality of
audits conducted by an independent
public accountant registered with, and
subject to regular inspection by, the
PCAOB.332 Further, as the PCAOB
develops and implements an inspection
program of broker-dealer audits as
contemplated by the Dodd-Frank Act,
that program will include inspection of,
among other things, ‘‘registered public
accounting firms’ current compliance
with laws, rules, and standards in
performing audits of brokers and
dealers.’’ 333 The requirement that all
broker-dealer independent public
accountants comply with the standards
established by the PCAOB should
facilitate the development and
implementation of its permanent
inspection program, as contemplated by
the Dodd-Frank Act.
As noted above, the PCAOB has
proposed an auditing standard for
supplemental information
accompanying audited financial
statements, including the supporting
schedules broker-dealers must file as
part of the financial report.334 The
PCAOB stated that a primary factor that
led it to reexamine its requirements
regarding supplemental information was
the Commission’s proposal to amend
the reporting requirements of Rule 17a–
5.335 In addition, as noted above, the
PCAOB has proposed specific
attestation standards for examining
compliance reports and reviewing
exemption reports. The PCAOB’s
proposing release noted that the
proposed standards ‘‘are tailored to the
requirements in SEC Proposed Rule
17a–5.’’ 336 The proposed standards, if
adopted, would establish a single and
broker-dealer-specific approach to
examining compliance reports and
reviewing exemption reports. This
should provide greater clarity as to
procedures an independent public
accountant should use in examining a
compliance report and reviewing an
exemption report.
With respect to comments suggesting
that PCAOB standards should apply
only to auditors of broker-dealers
‘‘permanently subject to PCAOB
inspection,’’ 337 the PCAOB has not
exempted the audits by independent
332 See Custody of Funds or Securities of Clients
by Investment Advisers, 75 FR at 1460.
333 See Temporary Rule for an Interim Program of
Inspection Related to Audits of Brokers and
Dealers, PCAOB Release No. 2011–001, PCAOB
Rulemaking Docket Matter No. 32, 1 (June 14,
2011).
334 See PCAOB Proposed Auditing Standard for
Supplemental Information.
335 Id. at 2–3.
336 See PCAOB Proposing Release at 5.
337 See AICPA Letter.
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public accountants of any class of
broker-dealer from the PCAOB’s
permanent inspection program.338 In
fact, the PCAOB has established an
interim inspection program for all
broker-dealer audits by independent
public accountants that will ‘‘allow the
Board to begin inspections of relevant
audits and auditors and provide a
source of information to help guide
decisions about the scope and elements
of a permanent program.’’ 339 The
PCAOB stated that it did not intend ‘‘to
postpone all use of its new inspection
authority until after those judgments
were made.’’ 340
At this time, there is no reason to
expect that any type of broker-dealer
audit will be exempt from the PCAOB’s
permanent inspection program, and any
PCAOB determination to exempt brokerdealer audits from the PCAOB’s
permanent inspection program must be
approved by the Commission.
Therefore, notwithstanding any such
exemption, paragraph (g) of Rule 17a–5
is amended to require that broker-dealer
independent public accountants prepare
reports covering the financial report and
compliance report or exemption report
in accordance with standards of the
PCAOB.
On August 20, 2012, the PCAOB
published its first report on the progress
of the interim inspection program.341
The report contains observations from
inspections of portions of 23 brokerdealer audits conducted by ten
independent public accounting firms
that were all conducted in accordance
with GAAS.342 The inspections did not
exclude any broker-dealer audits from
being eligible for selection.343 PCAOB
staff identified deficiencies in all of the
audits inspected.344 For example, as to
all of the 14 audits of broker-dealers that
claimed an exemption from Rule 15c3–
3, the staff stated that the accountant
‘‘did not perform sufficient procedures
to ascertain that the broker or dealer
complied with the conditions of the
exemption,’’ 345 and in 21 of the 23
audits, that the accountant ‘‘failed to
perform sufficient audit procedures to
338 See Public Company Accounting Oversight
Board: Order Approving Proposed Temporary Rule
for an Interim Program of Inspection Related to
Audits of Brokers and Dealers, Exchange Act
Release No. 65163 (Aug. 18, 2011), 76 FR at 52996
(Aug. 24, 2011).
339 Id. at 52997.
340 Id.
341 See PCAOB, Report on the Progress of the
Interim Inspection Program Related to Audits of
Brokers and Dealers, PCAOB Release No. 2012–005
(August 20, 2012) (‘‘PCAOB Inspection Report’’).
342 Id. at ii.
343 Id. at 8.
344 Id. at ii.
345 Id. at iii.
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obtain reasonable assurance that any
material inadequacies found to exist
since the date of the last examination
. . . would have been disclosed in the
accountant’s supplemental report.’’ 346
The deficiencies noted in the PCAOB’s
report on the progress of the interim
inspection program provide further
support for the amendments that the
Commission is adopting today to
establish the foundation for the
PCAOB’s development of standards that
are tailored to Rule 17a–5, and to
strengthen and facilitate consistent
compliance with broker-dealer audit
and reporting requirements.
Several commenters suggested that
the Commission delay the applicability
of these requirements because, among
other things, PCAOB standards
regarding broker-dealer audits,
including standards that apply to
compliance reports and exemption
reports, will not be final when these
rule amendments are adopted.347 In
response, as discussed below in section
V. of this release, the Commission is
delaying the effective dates of most of
the rule amendments. In accordance
with the effective dates, broker-dealers
must file compliance reports or
exemption reports, as applicable, and
broker-dealers must file reports of
independent public accountants
covering compliance reports or
exemption reports in accordance with
Rule 17a–5 as amended, for fiscal years
ending on or after June 1, 2014. In the
interim, broker-dealers must continue to
file material inadequacy reports in
accordance with the provisions of Rule
17a–5 as they existed before today’s
amendments. Broker-dealer
independent public accountants must
prepare reports based on an
examination of broker-dealer financial
reports in accordance with PCAOB
standards for fiscal years ending on or
after June 1, 2014. In the interim, audits
of broker-dealer financial statements
filed with the Commission under Rule
17a–5 should continue to be understood
to mean auditing standards generally
accepted in the U.S., plus any
applicable rules of the Commission.348
The June 1, 2014 effective date should
provide sufficient time for the PCAOB
to finalize, subject to Commission
approval, the standards for brokerdealer audits and for broker-dealers and
their independent public accountants to
346 Id.
347 See, e.g., CAQ Letter; Deloitte Letter; Grant
Thornton Letter; KPMG Letter; McGladrey Letter.
348 See Commission Guidance Regarding
Auditing, Attestation, and Related Professional
Practice Standards Related to Brokers and Dealers,
Exchange Act Release No. 62991 (Sept. 24, 2010),
75 FR 60616, 60617 (Oct. 1, 2010).
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51933
prepare to comply with the new
requirements and standards.
As noted above, one commenter
stated the Commission should provide
more guidance on what an independent
public accountant must address, and
that the requirement for PCAOB
standards should not be effective unless
the AICPA Broker-Dealer Audit Guide is
revised and updated.349 Another
commenter sought clarification on what
was expected of the auditor with respect
to the books and records assertion.350 In
response to these comments, the
Commission notes that the PCAOB’s
proposed standards with respect to the
examination of the compliance report by
the independent public accountant
address, among other things: (1) The
objective of the examination; (2) the
relationship between the examination
engagement and the audit of the
financial report; (3) considerations for
broker-dealers with multiple divisions
or branches; (4) identifying risks of
material non-compliance; (5) testing
controls over compliance; (6)
performing compliance tests; (7) testing
information used to assert compliance;
(8) evaluating the results of the
examination procedures; (9) subsequent
events; (10) obtaining a representation
letter; (11) communication
requirements; (12) reporting on the
examination engagement; (13) the
examination report date; and (14)
examination report modifications.351
The PCAOB’s proposed standards with
respect to the review of the exemption
report by the independent public
accountant address, among other things:
(1) The objective of the review; (2) the
relationship between the review
engagement and the audit of the
financial report; (3) the review
procedures; (4) evaluating the results of
the examination procedures; (5)
obtaining a representation letter; (6)
communication requirements; (7)
reporting on the review engagement; (8)
the review report date; and (9) review
report modifications.352 The
Commission expects that the final
standards of the PCAOB, which are
subject to Commission approval, will
provide sufficient guidance to
independent public accountants
performing examinations of compliance
reports and reviews of exemption
reports.
In response to the comment that the
requirements with respect to the
compliance reports and exemption
reports should not be effective unless
349 See
ABA Letter.
Grant Thorton Letter.
351 See PCAOB Proposing Release app. 1.
352 See PCAOB Proposing Release app. 2.
350 See
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the AICPA Broker-Dealer Audit Guide is
revised and updated, as stated above,
once adopted, only the standards of the
PCAOB apply to broker-dealer annual
reports. The PCAOB has proposed
standards with respect to the
examination of the compliance report
and the review of the exemption report
and it is expected that final standards
will be in place before the audit
requirements with respect to the
compliance report and the exemption
report are effective. Consequently, there
is no need to wait for the AICPA BrokerDealer Audit Guide to be updated.
As noted above, several commenters
requested clarity about the interaction
between material weaknesses in internal
control over financial reporting and
material weaknesses in internal control
over compliance with the financial
responsibility rules.353 Additionally,
one commenter stated that due to the
reliance placed on the financial books
and records of the broker-dealer, it will
not be feasible for the independent
public accountant to attest to the
effectiveness of internal control over the
financial responsibility rules without
also attesting to internal control over
financial reporting.354 As discussed
above in section II.B.3.iii. of this release,
although a broker-dealer is required to
state in the compliance report that the
information it used to state whether it
was in compliance with Rule 15c3–1
and paragraph (e) of Rule 15c3–3 was
derived from its books and records, the
final rule does not require that the
broker-dealer include a statement
regarding the effectiveness of its internal
control over the accuracy of its books
and records, nor does it require that the
independent public accountant attest to
the effectiveness of internal control over
the accuracy of the broker-dealer’s
books and records. Additionally, under
the final rule, the independent public
accountant is not required to opine on
the effectiveness of the broker-dealer’s
internal control over financial reporting.
However, the independent public
accountant’s existing obligation to gain
an understanding and perform
appropriate procedures relative to the
broker-dealer’s internal control over
financial reporting, as a necessary part
of the independent public accountant’s
financial report audit, remains
unchanged.355 Further, as discussed
above in section II.B.3.iii. of this release,
the examination of the compliance
report would pertain solely to certain
353 See
Deloitte Letter; KPMG Letter; PWC Letter.
354 See Van Kampen/Invesco Letter.
355 See PCAOB Auditing Standard, AS No. 12 (for
audits of fiscal years beginning on or after
December 15, 2010).
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statements in the compliance report and
not to the broker-dealer’s process for
arriving at the statements. The report of
the independent public accountant,
based on the examination of the
compliance report, requires the
accountant to perform its own
independent examination of the related
controls and procedures. Consequently,
it is not necessary for the independent
public accountant to provide an opinion
with regard to the process that the
broker-dealer used to arrive at its
conclusions.
As noted above, one commenter
stated that a review engagement should
not be employed for the exemption
report, because an accountant’s inquiry
and observation would not provide
sufficient evidence regarding a brokerdealer’s assertion that it is exempt from
Rule 15c3–3, and under the PCAOB’s
attestation standards, an auditor should
not accept an engagement to perform a
‘‘review’’ engagement related to an
entity’s compliance with specified
requirements.356 As an alternative, this
commenter suggested an ‘‘agreed-upon
procedures’’ approach or an
examination engagement.357
The PCAOB’s attestation standards
currently provide that an accountant
should not accept an engagement to
perform a review of an entity’s
compliance with specified requirements
or about the effectiveness of an entity’s
internal control over compliance, and
that an agreed upon procedures
engagement be considered as an
alternative.358 Irrespective of the
PCAOB’s current standards, Rule 17a–5,
as amended, provides that the brokerdealer engage an independent public
accountant to perform a review of the
exemption report. Moreover, in July
2011, as part of its proposed standards
for attestation engagements related to
broker-dealer compliance reports or
exemption reports, the PCAOB
proposed replacing the provision cited
by the commenter with the following:
‘‘When a practitioner is engaged to
perform a review engagement on
assertions made by a broker or dealer in
an exemption report that is prepared
pursuant to SEC Proposed Rule 17a–5,
the practitioner must conduct the
review engagement pursuant to
Proposed Attestation Standard, Review
Engagements Regarding Exemption
Reports of Brokers and Dealers.’’ 359 In
356 See
E&Y Letter.
357 Id.
358 See PCAOB Interim Attestation Standard, AT
Section 601 at ¶ 7.
359 See PCAOB Proposing Release app. 3 at A3–
4. The PCAOB’s attestation standards currently
provide that an accountant should not accept an
engagement to perform a review of an entity’s
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addition, as discussed above, the
PCAOB has proposed specific standards
for an accountant to perform a review of
the exemption report.360 The PCAOB’s
final standards, which must be
approved by the Commission, are
intended by the PCAOB to clarify the
procedures an independent public
accountant will need to perform in a
review of an exemption report.361
In response to the comment that a
review engagement should not be
employed for the exemption report
because inquiry and observation would
not provide sufficient evidence,362 the
independent public accountant would
be able to obtain the moderate level of
assurance contemplated by the required
review through a combination of
procedures that the accountant would
perform in connection with the
financial audit currently required under
Rule 17a–5 and certain inquiries and
other procedures specifically targeting
the exemption report. Also, the
PCAOB’s proposal includes specific
requirements for a review engagement
regarding exemption reports of brokers
and dealers. In addition to inquiry and
observation, the PCAOB’s proposal
states that ‘‘in performing the review
engagement, the auditor should . . .
[e]valuate whether the evidence
obtained and the results of the
procedures performed in the audit of the
financial statements and supplemental
information corroborate or contradict
the broker’s or dealer’s assertion
regarding compliance with the
exemption conditions.’’ 363
Additionally, the auditor should
‘‘[p]erform other procedures as
necessary in the circumstances to obtain
moderate assurance.’’ 364 The PCAOB’s
final standards will provide clarity on
the procedures to be performed by the
independent public accountant to
obtain a moderate level of assurance to
form a conclusion with respect to the
review of the exemption report.365
The commenter’s suggestion to use an
‘‘agreed-upon procedures’’ engagement
for the exemption report was
considered. The final rule, however,
requires a review engagement as
proposed. Under an ‘‘agreed-upon
procedures’’ engagement, the
independent public accountant is
compliance with specified requirements or about
the effectiveness of an entity’s internal control over
compliance or an assertion regarding those items.
See PCAOB Interim Attestation Standard, AT
Section 601 at ¶ 7.
360 See PCAOB Proposing Release app. 2.
361 Id.
362 See E&Y Letter.
363 See PCAOB Proposing Release app. 2.
364 Id.
365 Id.
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engaged by a client to issue a report of
findings based on specific procedures
performed on subject matter that the
specified parties believe are
appropriate.366 Additionally, in an
‘‘agreed-upon procedures’’ engagement,
the independent public accountant does
not perform an examination or a review,
and does not provide an opinion or
negative assurance. Thus, no conclusion
would be rendered as to the brokerdealer’s statement that it met certain
exemption provisions in Rule 15c3–3.
In addition to the commenter
advocating an ‘‘agreed-upon
procedures’’ standard,367 a second
commenter stated that the cost ‘‘would
not justify the need’’ for an audit report
covering the exemption report 368 and a
third commenter stated that the
exemption report should be replaced
with a box to check on the FOCUS
Report as the auditor attestation
provided no added benefit.369 In
response to all these comments, the
Commission notes that previously Rule
17a–5 required that if a broker-dealer is
exempt from Rule 15c3–3, the
independent public accountant is
required to ascertain whether the
conditions of the exemption were being
complied with and that no facts came to
the accountant’s attention to indicate
that the exemption had not been
complied with.370 Consequently, the
rule previously required the
independent public accountant to reach
a conclusion with respect to a brokerdealer’s claimed exemption from Rule
15c3–3. The Commission believes that
the rule should continue to require a
conclusion from the independent public
accountant on the broker-dealer’s
claimed exemption from Rule 15c3–3
because of the importance of
safeguarding customer securities and
cash. Consequently, the Commission
does not believe that it would be
appropriate to use a lower standard (i.e.,
the agreed-upon procedures standard) or
to have no requirement for the
independent public accountant to
perform any work with respect to the
exemption report. Moreover, because
the independent public accountant was
previously required to render a
conclusion with respect to the brokerdealer’s claimed exemption from Rule
15c3–3, the exemption report review
should not result in significant
366 See PCAOB Interim Attestation Standard, AT
Section 201 at ¶ .03.
367 See E&Y Letter.
368 See Citrin Letter.
369 See Angel Letter.
370 See 17 CFR 240.17a–5(g)(2).
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incremental cost over the existing
requirement.
As noted above, two commenters
raised concerns that minor exceptions to
meeting the exemption provisions of
paragraph (k) of Rule 15c3–3 could
result in the independent public
accountant becoming aware of material
modifications that should be made to
the statement in the exemption
report.371 Under PCAOB standards for
attestation engagements, the
independent public accountant’s review
report on a statement in an exemption
report would be required to include a
statement about whether the accountant
is aware of any material modifications
that should be made to the statement in
the exemption report in order for it to
be fairly stated in all material
respects.372 As discussed above in
section II.B.4.iii. of this release, the
exemption report requirements have
been modified from the proposal so that
a broker-dealer must either state that it
met the identified exemption provisions
in paragraph (k) throughout the most
recent fiscal year without exception or
that it met the identified exemption
provisions throughout the most recent
fiscal year except as described in the
report. Consequently, a broker-dealer
that had exceptions will state that fact
in the exemption report and describe
the exceptions. Under PCAOB
standards, if the statement is fairly
stated in all material respects, including
descriptions of any exceptions, the
broker-dealer’s independent public
accountant would not need to state that
the accountant is aware of any material
modifications that should be made to
the statement.373
The Commission did not receive
comments regarding the proposed
amendments to paragraph (i) of Rule
17a–5. However, the final rule has been
revised from the proposal for clarity and
consistency with the other amendments
371 See
CAI Letter; SIFMA letter.
PCAOB Interim Attestation Standard, AT
Section 101 at ¶ .90. See also PCAOB Proposing
Release app. 2 at ¶ 11 (‘‘The auditor should
evaluate the identified instances of non-compliance
with the exemption conditions to determine
whether the instances of non-compliance,
individually or in combination, cause the broker’s
or dealer’s assertion not to be fairly stated, in all
material respects. If the broker’s or dealer’s
assertion is not fairly stated, in all material respects,
the auditor should: (a) Modify the review report
. . . and (b) evaluate the effect of the matter on the
audit of the financial statements and supplemental
information.’’).
373 See PCAOB Interim Attestation Standard, AT
Section 101 at ¶ .67 (stating that in expressing its
conclusion, an independent public accounting
‘‘should consider an omission or a misstatement to
be material if the omission or misstatement—
individually or when aggregated with others—is
such that a reasonable person would be influenced
by the omission or misstatement.’’).
372 See
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to Rule 17a–5. The title of the rule has
been modified from the proposal to add
a citation for clarity. As adopted, the
title is, ‘‘Reports of the independent
public accountant required under
paragraph (d)(1)(i)(C) of [Rule 17a–5].’’
As adopted, paragraph (i)(1) of Rule
17a–5 provides, as proposed, that the
independent public accountant’s reports
must: Be dated; be signed manually;
indicate the city and state where issued;
and identify without detailed
enumeration the items covered by the
reports.
Paragraph (i)(2) of Rule 17a–5, as
adopted, is also consistent with the
proposal except that the word
‘‘Identify’’ is substituted for the word
‘‘Designate’’ for clarity and the phrase
‘‘opinions or conclusions’’ is substituted
for the phrase ‘‘opinions or statement’’
because as explained above, consistent
with auditing standards, a review
engagement will not result in an
opinion, but in the accountant’s
conclusion in the form of ‘‘negative
assurance’’—for example, a conclusion
that no information came to the
accountant’s attention that indicates
that a statement is not fairly stated in all
material respects.374 The rule therefore
provides that the independent public
accountant’s reports must: (i) State
whether the examinations or review, as
applicable, were made in accordance
with standards of the PCAOB; (ii)
identify any examination and, if
applicable, review procedures deemed
necessary by the independent public
accountant under the circumstances of
the particular case that have been
omitted and the reason for their
omission. The rule also provides that:
‘‘[n]othing in this section may be
construed to imply authority for the
omission of any procedure that
independent public accountants would
ordinarily employ in the course of an
examination or review made for the
purpose of expressing the opinions or
conclusions required under [Rule 17a–
5].’’
Paragraph (i)(3) of Rule 17a–5, as
adopted, is re-organized for clarity.
Specific reference has been added to
those statements in the compliance
report that the accountant must
examine, consistent with other
amendments to Rule 17a–5 (e.g., the
amendments to paragraph (g)(2)(i) of
Rule 17a–5 regarding the engagement of
the accountant to prepare a report based
on the examination of specified
statements in the compliance report). In
addition, a subparagraph is added to
include a reference to the exemption
374 Id.
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report.375 The rule provides that the
independent public accountant’s reports
must state clearly: (i) The opinion of the
independent public accountant with
respect to the financial report required
under paragraph (d)(1)(i)(A) of Rule
17a–5 and the accounting principles
and practices reflected in that report; (ii)
the opinion of the independent public
accountant with respect to the financial
report required under paragraph
(d)(1)(i)(A) of Rule 17a–5, as to the
consistency of the application of the
accounting principles, or as to any
changes in those principles, that have a
material effect on the financial
statements; and (iii) either (A) the
opinion of the independent public
accountant with respect to the
statements required under paragraphs
(d)(3)(i)(A)(2), (3), (4), and (5) of Rule
17a–5 in the compliance report required
under paragraph (d)(1)(i)(B)(1) of Rule
17a–5, or (B) the conclusion of the
independent public accountant with
respect to the statements required under
paragraphs (d)(4)(i), (ii), and (iii) of Rule
17a–5. The specific references to the
compliance report and exemption report
in paragraph (i)(3) are intended to
provide a complete description of what
must be contained in the report of the
independent public accountant under
current attestation standards, which
require a conclusion in the case of an
examination to be expressed in the form
of an opinion and a conclusion in the
case of a review that is not expressed in
the form of an opinion, but in the form
of ‘‘negative assurance.’’ 376
Paragraph (i)(4) of Rule 17a–5 has
been modified from the proposal to add
a reference to paragraph (d) to make it
more clear that the annual reports
referenced in the paragraph are the
financial report, compliance report, and
exemption report prescribed in
paragraph (d). In addition—in the
375 As proposed, paragraph (i)(3) did not contain
a reference to the exemption report. See BrokerDealer Reports, 76 FR at 37607. The final rule
makes clear that the auditor’s conclusion must be
included in the independent public accountant’s
report covering the exemption report.
376 As noted above, the accountant’s conclusion
in an examination engagement will be expressed in
the form of an opinion. For example, the
accountant’s conclusion based on an examination of
an assertion could state that in the accountant’s
opinion, the assertion is fairly stated in all material
respects. See, e.g., PCAOB Interim Attestation
Standard, AT Section 101 at ¶ .84. The accountant’s
conclusion in a review engagement will be
expressed, not in the form of an opinion, but in the
form of ‘‘negative assurance.’’ See, e.g., PCAOB
Interim Attestation Standard, AT Section 101 at ¶
.68. For example, the accountant’s conclusion based
on a review of an assertion could state that no
information came to the accountant’s attention that
indicates that the assertion is not fairly stated in all
material respects. See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ¶ .88.
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interest of using ‘‘plain English’’ in the
Commission’s rules—the word ‘‘must’’
has been substituted for the word
‘‘shall’’ and the word ‘‘thereto’’ has been
eliminated. The rule as adopted
therefore provides that ‘‘[a]ny matters to
which the independent public
accountant takes exception must be
clearly identified, the exceptions must
be specifically and clearly stated, and,
to the extent practicable, the effect of
each such exception on any related
items contained in the annual reports
required under paragraph (d) of [Rule
17a–5] must be given.’’
E. PCAOB Registration of Independent
Public Accountant—Paragraph (f)(1) of
Rule 17a–5
Prior to today’s amendments,
paragraph (f)(1) of Rule 17a–5 was titled
‘‘Qualification of accountants’’ and
provided that: ‘‘The Commission will
not recognize any person as a certified
public accountant who is not duly
registered and in good standing as such
under the laws of his place of residence
or principal office.’’ 377 Paragraph (f)(3)
of Rule 17a–5 provided that the
accountant ‘‘shall be independent in
accordance with the provisions of
§ 210.2–01 (b) and (c) of this chapter’’
and, paragraph (e)(1)(i) of Rule 17a–5
provided that the accountant ‘‘shall be
in fact independent as defined in
paragraph (f)(3) of this section.’’ 378
As discussed above, section
17(e)(1)(A) of the Exchange Act, as
amended by the Dodd-Frank Act,
requires registered broker-dealers to
annually file financial statements with
the Commission certified by ‘‘an
independent public accounting firm, or
by a registered public accounting firm if
the firm is required to be registered
under the Sarbanes-Oxley Act of 2002.’’
Accordingly, the Commission proposed
amending paragraph (f)(1) to provide
that: ‘‘The independent public
accountant must be qualified and
independent in accordance with
§ 210.2–01 of this chapter and, in
addition, the independent public
accountant must be registered with the
Public Company Accounting Oversight
Board if required by the Sarbanes-Oxley
Act of 2002.’’ 379 The Commission
further proposed deleting the
accountant independence language in
paragraph (e)(1)(i) of Rule 17a–5.380 In
addition, the Commission proposed
deleting paragraph (f)(3) and redesignating paragraph (f)(4) as
377 See
17 CFR 240.17a–5(f)(1).
17 CFR 240.17a–5(f)(3).
379 See Broker-Dealer Reports, 76 FR at 37593–
37594.
380 Id.
378 See
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paragraph (f)(3).381 These proposed
amendments to paragraph (f) of Rule
17a–5 would consolidate the provisions
of paragraphs (e)(1)(i), (f)(1), and (f)(3) of
Rule 17a–5 into paragraph (f)(1) and
make Rule 17a–5 consistent with other
Commission requirements governing the
qualifications of accountants. The
Commission received no comments on
these proposals and is adopting them
substantially as proposed.382
Although the underlying
independence requirements have not
changed, broker-dealers and their
independent public accountants are
reminded that they must comply with
the independence requirements of Rule
2–01 of Regulation S–X.383 As a result
of the Sarbanes-Oxley Act of 2002, Rule
2–01 of Regulation S–X was
strengthened, including increased
restrictions on the provision of certain
non-audit services to an audit client.384
Under the Commission’s rules, an
accountant will not be recognized as
independent with respect to an audit
client if the accountant is not, or a
reasonable investor with knowledge of
all relevant facts and circumstances
would conclude that the accountant is
not, capable of exercising objective and
impartial judgment on all issues
encompassed within the accountant’s
engagement. In determining whether an
accountant is independent, the
Commission will consider all relevant
circumstances, including all
relationships between the accountant
and the audit client, and not just those
relating to reports filed with the
Commission.385 The standard is
predicated largely on whether a
relationship or the provision of a
service: (1) Creates a mutual or
conflicting interest between the
accountant and the audit client; (2)
places the accountant in the position of
auditing his or her own work; (3) results
in the accountant acting as management
or an employee of the audit client; or (4)
places the accountant in a position of
being an advocate for the audit client.386
Further, Rule 2–01 of Regulation S–X
sets forth a non-exclusive specification
381 Id.
382 See paragraph (f)(1) of Rule 17a–5. The
Commission has revised paragraph (f)(1) of Rule
17a–5 from the proposal to: Change the title from
‘‘Qualification of accountants’’ to ‘‘Qualifications of
independent public accountant;’’ and deleting the
words ‘‘in addition.’’
383 See 17 CFR 210.2–01.
384 See Strengthening the Commission’s
Requirements Regarding Auditor Independence,
Exchange Act Release No. 47265 (Jan. 28, 2003), 68
FR 6006 (Feb. 5, 2003). See also Auditor
Independence: SEC Review of Auditor
Independence Rules, NASD Notice to Members 02–
19 (Mar. 2002).
385 See 17 CFR 210.2–01(b).
386 See 17 CFR 210.2–01, Preliminary Note 2.
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of circumstances that are inconsistent
with the general standard. For example,
the accountant is prohibited from
providing the following non-audit
services, among others, to an audit
client: 387
• Bookkeeping or other services
related to the accounting records or
financial statements of the audit client;
• Financial information systems
design and implementation; and
• Management functions or human
resources.
With respect to bookkeeping or other
services related to the accounting
records or financial statements of the
audit client, Rule 2–01(c)(4)(i) of
Regulation S–X specifies that these
services include: (1) Maintaining or
preparing the audit client’s accounting
records; (2) preparing financial
statements that are filed with the
Commission or the information that
forms the basis of financial statements
filed with the Commission; or (3)
preparing or originating source data
underlying the audit client’s financial
statements.388
Not all of the independence
requirements in Rule 2–01 of Regulation
S–X that are applicable to audits of
issuers are applicable to engagements
under Rule 17a–5. Specifically, auditors
of broker-dealers are not subject to the
partner rotation requirements or the
compensation requirements of the
Commission’s independence rules
because the statute mandating those
requirements is limited to issuers.389
Additionally, auditors of broker-dealers
are not subject to the audit committee
pre-approval requirements 390 or the
cooling-off period requirements for
employment 391 because those
requirements only reference issuers.
provide notification in certain
circumstances.394 For example,
paragraph (i) of Rule 15c3–3 requires a
carrying broker-dealer to immediately
notify the Commission and its DEA if it
fails to make a deposit into its customer
reserve account as required by
paragraph (e) of Rule 15c3–3.395
F. Notification of Non-Compliance or
Material Weakness
As discussed in detail below, the
Commission is amending the
notification provisions in Rule 17a–5
and amending Rule 17a–11 to align that
rule with the amendments to Rule 17a–
5. Under Rule 17a–11, a broker-dealer
must provide notice to the Commission
and its DEA in certain circumstances.392
For example, paragraph (b)(1) of Rule
17a–11 requires a broker-dealer to give
notice if its net capital declines below
the minimum amount required under
Rule 15c3–1.393 Rule 15c3–1 and Rule
15c3–3 also require broker-dealers to
i. The Proposed Amendments
387 See
17 CFR 210.2–01(c).
17 CFR 210.2–01(c)(4)(i).
389 See 15 U.S.C. 78j–1.
390 See 17 CFR 210.2–01(c)(7).
391 See 17 CFR 210.2–01(c)(2).
392 See 17 CFR 240.17a–11.
393 See 17 CFR 240.17a–11(b)(1).
388 See
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1. New Notification Requirements—
Paragraph (h) of Rule 17a–5
Prior to today’s amendments,
paragraph (h)(2) of Rule 17a–5 provided
that if, during the course of the audit or
interim work, the independent public
accountant determined that any
‘‘material inadequacies’’ existed, then
the independent public accountant was
required to inform the chief financial
officer (‘‘CFO’’) of the broker-dealer,
who, in turn, was required to give notice
to the Commission and the brokerdealer’s DEA within 24 hours in
accordance with the provisions of Rule
17a–11.396 The rule also provided that
the broker-dealer must furnish the
independent public accountant with the
notice, and if the independent public
accountant failed to receive the notice
within the 24 hour period, or if the
accountant disagreed with any
statements contained in the notice, the
independent public accountant was
required to inform the Commission and
the DEA within the next 24 hours.397 In
that event, the independent public
accountant was required to describe any
material inadequacies found to exist or,
if the broker or dealer filed a notice, the
independent public accountant was
required to detail the aspects of the
broker-dealer’s notice with which the
independent public accountant did not
agree.398
The proposed amendments to Rule
17a–5 would have replaced references
to material inadequacies, including the
material inadequacy report, with a
requirement applicable to carrying
broker-dealers to identify an instance of
‘‘material non-compliance’’ with the
financial responsibility rules and any
material weakness in internal control
over compliance with the financial
responsibility rules in the compliance
report and the requirement to engage an
independent public accountant to
394 See, e.g., 17 CFR 240.15c3–1(a)(6)(iv)(B); 17
CFR 240.15c3–1(a)(6)(v); 17 CFR 240.15c3–
1(a)(7)(ii); 17 CFR 240.15c3–1(c)(2)(x)(C)(1); 17 CFR
240.15c3–1(e); 17 CFR 240.15c3–1d(c)(2); 17 CFR
240.15c3–3(i).
395 See 17 CFR 240.15c3–3(i).
396 See 17 CFR 240.17a–5(h)(2).
397 Id.
398 Id.
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51937
examine the compliance report.399
Consistent with those proposed
changes, the Commission proposed
amending the notification provisions of
paragraph (h)(2) of Rule 17a–5 to
replace the term ‘‘material inadequacy’’
with the term ‘‘material noncompliance,’’ which would result in a
requirement to notify the Commission
upon the discovery by the accountant
during the course of preparing a report
based on an examination of the
compliance report of an instance of
material non-compliance as that term
was proposed to be defined under the
amendments.400
The Commission also proposed
amending provisions regarding the
notification process.401 Under the
proposal, the accountant would have
been required to notify the Commission
and the broker-dealer’s DEA directly.402
In the proposing release, the
Commission stated that it preliminarily
believed these changes would provide
more effective and timely notice of
broker-dealer compliance deficiencies
and enable the Commission to react
more quickly to protect customers and
others adversely affected by those
deficiencies.403 The amendments also
would have been consistent with the
notification requirement in Rule 206(4)–
2 that is triggered in the context of a
‘‘surprise’’ examination of an
investment adviser.404
ii. Comments Received
The Commission received numerous
comments in response to this
proposal.405 Most of these commenters
objected to the proposed notification
process.406 Among the reasons given
were that it would be inappropriate to
require the accountant to notify the
Commission and the DEA directly,
because, among other things, the brokerdealer is principally responsible for
compliance with the securities laws,
399 See Broker-Dealer Reports, 76 FR at 37575–
37579.
400 Id. at 37579.
401 Id.
402 Id.
403 Id.
404 Id. Rule 206(4)–2 provides, in pertinent part,
that upon finding any ‘‘material discrepancies’’
during the ‘‘surprise’’ examination of an investment
adviser to verify client funds and securities, the
independent public accountant must notify the
Commission within one business day. 17 CFR
275.206(4)–2(a)(4)(ii).
405 See ABA Letter; CAI Letter; CAQ Letter;
Deloitte Letter; E&Y Letter; Grant Thornton Letter;
KPMG Letter; McGladrey Letter; PWC Letter; SIFMA
Letter; Van Kampen/Invesco Letter.
406 See ABA Letter; CAI Letter; CAQ Letter;
Deloitte Letter; E&Y Letter; Grant Thornton Letter;
KPMG Letter; McGladrey Letter; PWC Letter; Van
Kampen/Invesco Letter.
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including timely notification; 407 that
PCAOB standards provide that ‘‘the
practitioner should not take on the role
of the responsible party;’’ 408 and that
PCAOB attestation standards (which
were referenced in the proposing
release) clearly provide that
management is responsible for the
subject matter to which it is asserting,
and not the accountant.409 In addition,
one commenter stated that alignment of
notification procedures (that is, to
require the accountant to notify the
Commission directly) between Rule
17a–5 and Rule 206(4)–2 is not
necessary, given the other auditing and
reporting responsibilities in place or
proposed.410 In addition to suggestions
that the notification process that existed
prior to today’s amendments should not
be changed,411 one commenter stated
that the rule should require
simultaneous notice by the accountant
to the Commission and to the firm’s
management.412
In addition, one commenter asked
whether the notification provisions
apply to a review of the exemption
report.413 Another commenter stated
that a report of non-compliance also
will trigger a Rule 17a–11 notice, which
would be duplicative and create
confusion.414
iii. The Final Rule
In part in response to comments
received, and to achieve consistency
with other revisions to the proposed
rule amendments described above, the
notification provisions in the final rule
have been modified from the proposed
amendments.415 First, the Commission
is persuaded by comments received that
the primary obligation to notify the
Commission should remain with the
broker-dealer.416 Therefore, the
407 See
Deloitte Letter.
KPMG Letter. See also PCAOB Interim
Attestation Standard, AT Section 101 at ¶ .13.
409 See PWC Letter. See also PCAOB Interim
Attestation Standard, AT Section 101 at ¶¶ .11–.13.
410 See E&Y Letter.
411 See, e.g., ABA Letter; E&Y Letter; McGladrey
Letter.
412 See Van Kampen/Invesco Letter.
413 See KPMG Letter.
414 See ABA Letter.
415 See paragraph (h) of Rule 17a–5.
416 As the proposal noted, the proposed
amendment to require the independent public
accountant to notify the Commission directly of
material non-compliance would have been
consistent with the surprise examination
notification requirement in Rule 206(4)–2 under the
Advisers Act. A surprise examination of an
investment adviser by an independent public
accountant generally verifies that client funds and
securities of which the investment adviser has
custody are held by a qualified custodian, such as
a bank or broker-dealer. The accountant’s surprise
examination report opines on the adviser’s
compliance with the custody rule requirement that
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408 See
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notification process in place before
today’s amendments generally has been
retained.
Second, the final rule amendments
require that, if the independent public
accountant determines that the brokerdealer ‘‘is not in compliance with’’ any
of the financial responsibility rules
during the course of preparing the
accountant’s reports, the independent
public accountant must immediately
notify the broker-dealer’s CFO of the
nature of the non-compliance.417 As
client funds and securities are maintained by a
qualified custodian and also opines on the adviser’s
compliance with certain recordkeeping obligations
between surprise examinations. The difference in
nature and scope of custodial and other activities
between broker-dealers and advisers results in
significantly broader examination requirements for
broker-dealers. Broker-dealers are required to
undergo an annual examination by an independent
public accountant of their financial statements and
certain supporting schedules: A computation of net
capital under Rule 15c3–1, a computation for
determining reserve requirements under Rule 15c3–
3, and information relating to the possession and
control requirements of Rule 15c3–3. Moreover,
under today’s amendments, the independent public
accountant must examine the compliance report of
broker-dealers that maintain custody of customer
funds or securities. The differences in the overall
nature of an examination also supports continuing
to maintain today’s model under which a brokerdealer has the primary notification obligation (e.g.,
unlike in the case of a surprise examination of an
investment adviser, a broker-dealer would already
be making its own assessment and preparing its
own report in the case of a compliance report
examination). Further, the Dodd-Frank Act
provided the PCAOB with explicit authority to,
among other things, establish (subject to
Commission approval) auditing and related
attestation, quality control, ethics, and
independence standards for registered public
accounting firms with respect to their preparation
of audit reports to be included in broker-dealer
filings with the Commission, and the authority to
conduct and require an inspection program of
registered public accounting firms that audit brokerdealers. The PCAOB oversight of broker-dealer
examinations provides additional regulatory
oversight with respect to the examination of the
broker-dealer further supporting the retention of the
primary obligation with the broker-dealer to
provide notice to the Commission and the brokerdealer’s DEA.
417 Id. Under the current provisions of paragraph
(h) of Rule 17a–5 (which are being amended), the
independent public accountant ‘‘shall call it to the
attention’’ of the CFO of the broker-dealer any
material inadequacies. See 17 CFR 240.17a–5(h)(2).
In the final rule, the independent public accountant
is required to ‘‘immediately notify’’ the CFO of the
‘‘nature’’ of any non-compliance with the financial
responsibility rules or material weakness. This
change from the current notification requirement is
designed to make the rule more clear as ‘‘shall call
it to the attention’’ does not specify when the
notification must be given. Further, as proposed,
the independent public accountant would have
been required to provide the Commission with
notice of any material non-compliance within one
business day of determining that the material noncompliance exists. See Broker-Dealer Reports, 76 FR
at 37606. Under the final rule, the independent
public accountant provides notice to the brokerdealer’s CFO of any non-compliance with the
financial responsibility rules or material weakness
and the CFO, in turn, is required to provide the
Commission and other securities regulators with
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proposed, the independent public
accountant would have been required to
provide notification if the accountant
determined that any ‘‘material noncompliance’’ existed. As discussed
above in section II.D.3. of this release,
the final rule does not include a
definition of the term material noncompliance, as in the proposal. Thus,
the independent public accountant will
be required to provide notification to
the broker-dealer of all instances of noncompliance with the financial
responsibility rules as opposed to the
proposal, which required the
independent public accountant to report
to the Commission and the DEA only
instances of material non-compliance.
While this may increase the number of
times the independent public
accountant must provide notification of
non-compliance with the financial
responsibility rules, the independent
public accountant will not have to
analyze whether an instance of noncompliance is ‘‘material noncompliance’’ under the proposed
definition.
If the independent public accountant
provides notice to the broker-dealer of
an instance of non-compliance with the
financial responsibility rules, the
broker-dealer must provide notice to the
Commission and its DEA in accordance
with the notification provisions of Rule
15c3–1, Rule 15c3–3, or Rule 17a–11,
but only if the notice provided by the
independent public accountant
concerns an instance of non-compliance
that requires the broker-dealer to
provide notification under those rules.
The proposal would have required the
accountant to notify the Commission
‘‘upon determining that any material
non-compliance exists.’’ 418 Rule 15c3–
1, Rule 15c3–3, and Rule 17a–11 specify
instances of non-compliance that
require notification by the broker-dealer,
and paragraph (h) of Rule 17a–5, as
amended, refers to the notification
provisions in those rules.
The broker-dealer must provide a
copy of the notification to the
accountant within one business day
and, if the accountant does not receive
the notice or the accountant does not
agree with any statements in the notice,
the accountant must provide a report to
the Commission and the broker-dealer’s
notice if the non-compliance requires notice under
Rule 15c3–1, Rule 15c3–3, or Rule 17a–11 or in the
case of a material weakness. Consequently, because
there is an intermediate step before the Commission
receives notice, it is important that the independent
public accountant notify the CFO immediately so
that the Commission and other securities regulators
receive timely notice.
418 See Broker-Dealer Reports, 76 FR at 37606.
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DEA within one business day.419 The
report from the accountant must, if the
broker-dealer failed to file a notification,
describe any instances of noncompliance that required the brokerdealer to provide a notification.420 If the
broker-dealer filed a notification but the
independent public accountant does not
agree with the statements in the notice,
the report from the accountant must
detail the aspects of the notification of
the broker-dealer with which the
accountant does not agree.421 This
notification process is generally the
same as that in place before today’s
amendments.
While the final rule incorporates the
existing notification process, the
Commission wants to emphasize the
importance of broker-dealers providing
notification to the Commission and
other securities regulators of noncompliance with Rule 15c3–1 as
required by Rule 17a–11 and noncompliance with paragraph (e) of Rule
15c3–3 as required by paragraph (i) of
Rule 15c3–3.422 Consequently, the
Commission is adding a note to
paragraph (h) of Rule 17a–5 calling the
attention of the broker-dealer and
independent public accountant to these
notification requirements.423 Further, an
important element of this process is the
back-up provided by the independent
public accountant in terms of the
obligation under the rule to provide the
Commission and DEA with notification
of the instance of non-compliance if the
419 See
paragraph (h) of Rule 17a–5.
420 Id.
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421 Id.
422 Paragraph (b)(1) of Rule 17a–11 provides,
among other things, that every broker-dealer whose
net capital declines below the minimum amount
required pursuant to Rule 15c3–1 shall give notice
of such deficiency that same day in accordance
with paragraph (g) of Rule 17a–11 and that the
notice shall specify the broker-dealer’s net capital
requirement and its current amount of net capital.
See 17 CFR 240.17a–11(b)(1). Paragraph (g) of Rule
17a–11 provides, among other things, that the
notice shall be given or transmitted to the principal
office of the Commission in Washington, DC, the
regional office of the Commission for the region in
which the broker-dealer has its principal place of
business, the DEA of which such broker-dealer is
a member, and the CFTC if the broker-dealer is
registered as a futures commission merchant with
such Commission, and that the notice shall be given
or transmitted by telegraphic notice or facsimile
transmission. See 17 CFR 240.17a–11(g). Paragraph
(i) of Rule 15c3–3 provides that if a broker-dealer
shall fail to make a reserve bank account or special
account deposit, as required by Rule 15c3–3, the
broker-dealer shall by telegram immediately notify
the Commission and the regulatory authority for the
broker-dealer, which examines such broker-dealer
as to financial responsibility and shall promptly
thereafter confirm such notification in writing. See
17 CFR 240.15c3–3(i). The Commission staff is
considering ways to modernize the process by
which broker-dealers file these and other notices
with the Commission.
423 See note to paragraph (h) of Rule 17a–5, as
adopted.
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accountant does not receive a copy of
the broker-dealer’s notification or the
accountant does not agree with the
statements in the notification.
Therefore, of necessity, the independent
public accountant would have to have
measures in place to determine whether,
and if so when, the accountant received
a copy of the notification required to be
provided by the broker-dealer to the
Commission or the broker-dealer’s DEA.
An independent public accountant
could decide not to rely solely on the
receipt of a copy of the notice from the
broker dealer and take other steps to
check whether the broker-dealer
provided notice to the Commission and
the DEA, such as obtaining a copy of a
facsimile transmission from the brokerdealer to the Commission and DEA.
Third, the proposal has been modified
to add that, if the accountant determines
in connection with the audit of a
carrying broker-dealer’s annual reports
that any material weakness (as defined
in paragraph (d)(3)(iii) of Rule 17a–5)
exists, the independent public
accountant must immediately notify the
broker-dealer’s CFO of the nature of the
material weakness.424 As discussed
above, before today’s amendments,
paragraph (h)(2) of Rule 17a–5 required
the accountant to notify the brokerdealer’s CFO if the accountant
determined that any ‘‘material
inadequacies’’ existed. However, as
explained above in section II.B.3. of this
release, the final rules do not contain
the concept of material inadequacy.
Also, as the term material weakness is
defined with respect to the compliance
report, this notification requirement
only applies to carrying broker-dealers,
whereas the requirement to provide
notification of a material inadequacy
applied to carrying and non-carrying
broker-dealers.
As discussed in more detail below in
section II.F.2. of this release, the
Commission is amending Rule 17a–11
to provide that a broker-dealer must
provide notification to the Commission
and its DEA if the broker-dealer
discovers, or is notified by its
independent public accountant, of the
existence of a material weakness.425
Paragraph (h) of Rule 17a–5, as stated
above, requires that the independent
public accountant notify the brokerdealer if the accountant determines that
a material weakness exists.426 The rule
also requires the broker-dealer to
provide notice in accordance with the
provisions of Rule 17a–11, which,
among other things, require the broker424 See
paragraph (h) of Rule 17a–5.
paragraph (e) of Rule 17a–11.
426 See paragraph (h) of Rule 17a–5.
425 See
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51939
dealer to provide notice to the
Commission and its DEA in accordance
with paragraph (g) of Rule 17a–11
within 24 hours and transmit a report
within 48 hours of the notice stating
what the broker-dealer has done or is
doing to correct the situation.427
Paragraph (h) of Rule 17a–5 requires the
broker-dealer to provide the accountant
with a copy of the notice it sends to the
Commission within one business day
and, if the accountant does not receive
the notice or the accountant does not
agree with the statements in the notice,
the accountant must provide a report to
the Commission and the broker-dealer’s
DEA within one business day.428 The
report from the accountant must, if the
broker-dealer failed to file a notification,
describe any material weakness.429 If
the broker-dealer filed a notification and
the accountant does not agree with the
statements in the notification, the report
from the accountant must detail the
aspects of the notification of the brokerdealer with which the accountant does
not agree.430 Again, this notification
process is generally the same as the one
in place before today’s amendments.431
In response to the comment that the rule
should require simultaneous notice by
the accountant to the Commission and
to the firm’s management, the
notification procedures adopted today
require that the accountant notify
management of the broker-dealer and
also ensure that the Commission
receives timely notice.
As stated above, one commenter
asked whether the notification
provisions apply to a review of an
exemption report.432 The notification
provisions in paragraph (h) of Rule 17a–
5 with respect to non-compliance with
the financial responsibility rules apply
regardless of whether the independent
public accountant is engaged to prepare
a report based on examination of a
broker-dealer’s compliance report or a
review of a broker-dealer’s exemption
report.433 An independent public
accountant may determine that a brokerdealer is not in compliance with a
requirement in the financial
responsibility rules (e.g., not in
compliance with Rule 15c3–1) during
427 See paragraph (h) of Rule 17a–5; 17 CFR
240.17a–11(g).
428 See paragraph (h) of Rule 17a–5.
429 Id.
430 Id.
431 One change from the current rule (which is
being amended) is to provide that required actions
be completed within ‘‘one business day’’ as
opposed to within a ‘‘24 hour period.’’ This change
is designed to account for non-business days during
which certain actions may not be feasibly
completed.
432 See KPMG Letter.
433 See paragraph (h) of Rule 17a–5.
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the course of an audit engagement of a
non-carrying broker-dealer that files an
exemption report either as part of the
examination of the broker-dealer’s
financial statements or the review of
certain statements the broker-dealer’s
exemption report. In this case, the
independent public accountant would
need to immediately notify the CFO of
the broker-dealer of the nature of the
non-compliance. The notification
provisions with respect to an instance of
material weakness only apply to brokerdealers that file a compliance report
because material weakness is defined
for purposes of the compliance report.
The rule as amended does not require
the accountant to notify the Commission
directly when the accountant
determines that a non-compliance with
the financial responsibility rules exists,
which eliminates the concern of a
commenter that a report of noncompliance by the accountant, as
proposed, would also trigger a Rule
17a–11 notice, which would be
duplicative and create confusion.434 As
adopted, the responsibility to provide
notification rests with the broker-dealer
in the first instance.
2. Conforming and Technical
Amendments to Rule 17a–11
Before today’s amendments,
paragraph (e) of Rule 17a–11 provided
that whenever a broker-dealer
discovered, or was notified by an
independent public accountant,
pursuant to paragraph (h)(2) of Rule
17a–5 or paragraph (f)(2) of Rule 17a–12
of the existence of any material
inadequacy as defined in paragraph (g)
of Rule 17a–5 or paragraph (e)(2) of Rule
17a–12, the broker-dealer was required
to give notice to the Commission within
24 hours of the discovery or notification
and transmit a report to the Commission
within 48 hours of the notice stating
what the broker-dealer has done or was
doing to correct the situation.435 The
Commission proposed amending
paragraph (e) of Rule 17a–11 to delete
the references to Rule 17a–5 and to
correct the references to Rule 17a–12.436
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434 See
ABA Letter.
435 See 17 CFR 240.17a–11(e).
436 See Broker-Dealer Reports, 76 FR at 37579.
Rule 17a–12 contains reporting requirements for
over-the-counter (‘‘OTC’’) derivatives dealers. See
17 CFR 240.17a–12. The rule is similar to Rule 17a–
5. Compare 17 CFR 240.17a–12, with 17 CFR
240.17a–5. For example, paragraph (h)(2) of Rule
17a–12 describes material inadequacies and
paragraph (i)(2) of Rule 17a–12 provides that if the
accountant determines that any material
inadequacy exists, the accountant must call it to the
attention of the CFO of the OTC derivatives dealer,
who must inform the Commission. See 17 CFR
240.17a–12(h)(2) and (i). The Commission did not
propose amending Rule 17a–12. Consequently, Rule
17a–12 retains the concept of material inadequacy.
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One commenter stated that the
current notification process under
paragraph (h)(2) of Rule 17a–5 and
paragraph (e) of Rule 17a–11 satisfies
the objective of notifying the
Commission in a timely manner and
that the commenter was concerned that
the proposal could undermine the
effectiveness of the notification process
in part because it would require notice
to the Commission only when the
accountant determines that there is a
deficiency, and not when it is
independently discovered by the brokerdealer.437
The Commission agrees with the
commenter that notification should be
provided to the Commission when a
deficiency in internal control is
discovered by the broker-dealer, in
addition to when it is notified by its
accountant of the existence of any
material weakness. Therefore, the final
rule retains references to Rule 17a–5 in
paragraph (e) of Rule 17a–11. The
Commission is conforming paragraph (e)
of Rule 17a–11 to today’s amendments
to Rule 17a–5 to substitute the term
material weakness as defined in
paragraph (d)(3)(iii) of Rule 17a–5 for
the term material inadequacy with
respect to Rule 17a–5 and to replace the
reference to paragraph (h)(2) of Rule
17a–5 with a reference to paragraph (h)
of Rule 17a–5. Specifically, the final
rule provides that whenever a brokerdealer discovers, or is notified by its
accountant under paragraph (h) of Rule
17a–5 of the existence of any material
weakness, the broker-dealer must: (1)
Give notice of the material weakness
within 24 hours of the discovery or
notification; and (2) transmit a report
within 48 hours of the notice stating
what the broker or dealer has done or
is doing to correct the situation.438 The
rule retains a reference to material
inadequacy as defined in paragraph
(h)(2) of Rule 17a–12, but the
amendments correct citations to that
rule.
G. Other Amendments to Rule 17a–5
1. Information Provided to Customers—
Paragraph (c) of Rule 17a–5
i. Background
Paragraph (c) of Rule 17a–5 generally
requires a broker-dealer that carries
customer accounts to send its balance
sheet with appropriate notes and certain
other financial information to each of its
437 See
Deloitte Letter.
paragraph (e) of Rule 17a–11. As stated
above, this provision only applies to broker-dealers
that file compliance reports, as the tern material
weakness is defined with respect to the compliance
report.
438 See
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customers twice a year.439 The
Commission did not propose to amend
this requirement. Accordingly, a brokerdealer that carries customer accounts
must continue to send its customers: (1)
An audited balance sheet with
footnotes, including a footnote
specifying the amount of the brokerdealer’s net capital and required net
capital, under paragraph (c)(2) of Rule
17a–5; 440 and (2) an unaudited balance
sheet dated six months after the date of
the audited balance sheet with
footnotes, including a footnote regarding
the amount of the broker-dealer’s net
capital and required net capital, under
paragraph (c)(3) of Rule 17a–5.441 The
information required by paragraphs
(c)(2) and (c)(3) of Rule 17a–5 must
either be mailed to customers, or, if the
broker-dealer meets certain conditions
under paragraph (c)(5) of Rule 17a–5,
the broker-dealer can semi-annually
send its customers summary
information regarding its net capital, as
long as it also provides customers with
a toll-free number to call for a free copy
of its balance sheet with appropriate
notes, makes its balance sheet with
appropriate notes available to customers
on its Web site, and meets other
specified requirements.442
ii. Availability of Independent Public
Accountant’s Comments on Material
Inadequacies—Paragraph (c)(2) of Rule
17a–5
Prior to today’s amendments,
paragraph (c)(2)(iii) of Rule 17a–5
provided that if, in conjunction with a
broker-dealer’s most recent audit report,
the broker-dealer’s independent public
accountant commented on any material
inadequacies in the broker-dealer’s
internal controls, its accounting system,
or certain of its practices and
procedures 443 under paragraphs (g) and
(h) of Rule 17a–5, and paragraph (e) of
Rule 17a–11, the broker-dealer’s audited
statements sent to customers were
required to include a statement that a
copy of the auditor’s comments were
available for inspection at the
Commission’s principal office in
Washington, DC, and the regional office
of the Commission in which the broker439 See
17 CFR 240.17a–5(c).
CFR 240.17a–5(c)(2).
441 17 CFR 240.17a–5(c)(3).
442 See 17 CFR 240.17a–5(c)(5). See also BrokerDealer Exemption from Sending Certain Financial
Information to Customers, Exchange Act Release
No. 48282 (Aug. 1, 2003), 68 FR 46446 (Aug. 6,
2003).
443 These practices and procedures include, for
example, periodic net capital computations under
Rule 15c3–1 and periodic counts of securities under
Rule 17a–13.
440 17
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dealer had its principal place of
business.444
As discussed above in sections II.D.3.
and II.F. of this release, the Commission
proposed deleting references to, and the
definition of, the term material
inadequacy in Rule 17a–5, and
proposed amending paragraph (h) of
Rule 17a–5 to require a broker-dealer’s
independent public accountant to notify
the Commission and the broker-dealer’s
DEA if the accountant determined that
any material non-compliance existed at
the broker-dealer during the course of
preparing its reports.445 Consequently,
the Commission proposed replacing
paragraph (c)(2)(iii) of Rule 17a–5,
which contained the term material
inadequacies, with a requirement that, if
a broker-dealer’s accountant provided
notice to the Commission of an instance
of material non-compliance, the
financial information sent to customers
under paragraph (c)(2) of Rule 17a–5
must include a statement that a copy of
the accountant’s notice was available for
customers’ inspection at the principal
office of the Commission in
Washington, DC.446 Under this
proposal, notices to the Commission
regarding an accountant’s determination
that one or more instances of material
non-compliance existed at a brokerdealer would be publicly available.
Three commenters responded to the
proposed amendments to paragraph
(c)(2) of Rule 17a–5.447 These
commenters each stated that the
Commission should accord confidential
treatment to accountants’ notices to the
Commission regarding determinations
of material non-compliance.448 One
commenter stated that due to the
technical nature of the financial
responsibility rules, there was a risk that
notices of material non-compliance
could be misinterpreted by the media
and others.449
The Commission is revising its
proposal to amend paragraph (c)(2) of
Rule 17a–5 to be consistent with the
new notification provisions in
paragraph (h) described above relating
to the identification by a broker-dealer’s
accountant of a material weakness
rather than an instance of material noncompliance.450 Specifically, if, in
connection with the most recent annual
444 See
17 CFR 240.17a–5(c)(2)(iii).
Broker-Dealer Reports, 76 FR at 37579.
446 This proposal would have been codified in
paragraph (c)(2)(iv) of Rule 17a–5 as a result of
paragraph (c)(2)(iii) being removed and paragraph
(c)(2)(iv) being redesignated as paragraph (c)(iii).
See Broker-Dealer Reports, 76 FR at 37603.
447 See ABA Letter; CAI Letter; Deloitte Letter.
448 Id.
449 See ABA Letter.
450 See paragraph (c)(2)(iv) of Rule 17a–5.
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reports, the report of the independent
public accountant covering the brokerdealer’s compliance report identifies a
material weakness, the broker-dealer
must include a statement that one or
more material weaknesses have been
identified and that a copy of the report
of the independent public accountant is
currently available for the customer’s
inspection at the principal office of the
Commission in Washington, DC, and the
regional office of the Commission for
the region in which the broker-dealer
has its principal place of business.451
In response to commenters’ concerns
about making the report of material noncompliance available to the public, the
report that now will be made publicly
available is a report that identifies the
existence of a material weakness—not a
report of material non-compliance. In
addition, making the report of the
independent public accountant covering
the compliance report publicly available
if it identifies the existence of a material
weakness is consistent with the
previous treatment of a report of a
material inadequacy. Providing
customers notice of an accountant’s
finding that goes directly to the
financial and operational condition of
their broker-dealer and making the
report containing the finding publicly
available will make available to
customers information that facilitates
their ability to make more informed
decisions in selecting broker-dealers
through which they prefer to conduct
business. For these reasons, the final
rule does not accord confidential
treatment to a report of an independent
public accountant covering the
compliance report if it identifies a
material weakness as some commenters
suggested should be the case with
respect to the proposed—but not
adopted—report of material noncompliance. Consequently, an
independent public accountant’s report
covering the compliance report will be
made available for the customer’s
inspection at the principal office of the
Commission in Washington, DC, and the
regional office of the Commission for
the region in which the broker-dealer
has its principal place of business if the
report identifies the existence of a
material weakness.452
451 Id.
452 Paragraph (c)(2)(iv) of Rule 17a–5, as adopted,
includes both the principal office of the
Commission in Washington, DC and the regional
office of the Commission for the region in which a
broker-dealer has its principal place of business as
locations where the accountant’s reports are
available. Including the applicable regional office of
the Commission as a location where these notices
are available will make them more accessible to
customers and is consistent with the previous
treatment of material inadequacy reports.
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iii. Exemption From Mailing Financial
Information to Customers—Paragraph
(c)(5) of Rule 17a–5
Before today’s amendments,
paragraph (c)(5) of Rule 17a–5 provided
a conditional exemption from the
requirement that a broker-dealer send
paper copies of financial information to
customers if the broker-dealer mailed to
customers a financial disclosure
statement with summary information
and an Internet link to its balance sheet
and other information on the brokerdealer’s Web site.453 One of the
conditions of the exemption, contained
in paragraph (c)(5)(vi) of Rule 17a–5,
was that the broker-dealer was not
required by paragraph (e) of Rule 17a–
11 to give notice of a material
inadequacy during the prior year. The
Commission proposed revising the
condition in paragraph (c)(5)(vi) of Rule
17a–5 to provide that the broker-dealer’s
financial statements must receive an
unqualified opinion from the
independent public accountant and
neither the broker-dealer, under
proposed paragraph (d) of Rule 17a–5,
nor the independent public accountant,
under proposed paragraph (g) of Rule
17a–5, identified a material weakness or
an instance of material noncompliance.454
The Commission received several
comments on the proposal.455 One
commenter stated that broker-dealers
should be able to deliver the financial
information available to customers via
its Web site regardless of whether an
instance of material non-compliance or
material weakness was identified.456
Another commenter stated that the rule
should not require a 100% rate of
compliance with the financial
responsibility rules to qualify for the
exemption.457 A third commenter stated
that the proposed amendment should be
eliminated, or replaced with the
requirement that broker-dealers include
a notice of the material weakness or
non-compliance on customer account
453 17
CFR 240.17a–5(c)(5).
Broker-Dealer Reports, 76 FR at 37577.
455 See ABA Letter; CAI Letter; SIFMA Letter.
456 See ABA Letter.
457 See CAI Letter. This commenter stated that as
FINRA has proposed that broker-dealers send
customer account statements monthly instead of
quarterly, broker-dealers are already potentially
facing ‘‘extremely high’’ costs of sending
information to customers. FINRA withdrew its
proposals to send customer account statements
monthly instead of quarterly on July 30, 2012. See
Proposed Rule Change to Adopt FINRA Rule 2231
(Customer Account Statements) in the Consolidated
FINRA Rulebook, File No. SR–2009–028, (July 30,
2012), available at https://www.finra.org/web/
groups/industry/@ip/@reg/@rulfil/documents/
rulefilings/p143262.pdf (withdrawal of proposed
rule change).
454 See
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statements for a year following its
identification.458
In response to comments received, the
Commission has decided not to adopt
the proposed condition in paragraph
(c)(5)(vi) of Rule 17a–5 for qualifying for
the conditional exemption. Requiring
paper delivery of financial information
to customers when a broker-dealer’s
financial statements do not receive an
unqualified opinion from its
independent public accountant, or
when the broker-dealer fails to comply
with certain regulatory requirements,
will not necessarily result in a more
effective means of communication to
customers and runs counter to the
dominant trend toward electronic
communications between financial
entities and their customers. Further, as
discussed above, if a broker-dealer or its
independent public accountant provides
notice to the Commission of a material
weakness in the broker-dealer’s Internal
Control Over Compliance, paragraph
(c)(2)(iv) of Rule 17a–5 as adopted
requires the broker-dealer to include
with the semi-annual financial
disclosure statement it sends its
customers a statement that the
independent public accountant
identified a material weakness and that
a copy of the report of the independent
public accountant is available for the
customers’ inspection.
2. Technical Amendments
i. Deletion of Paragraph (b)(6) of Rule
17a–5
Before today’s amendments,
paragraph (b)(6) of Rule 17a–5 provided
that ‘‘a copy of [a broker-dealers] annual
audit report shall be filed at the regional
office of the Commission for the region
in which the broker or dealer has its
principal place of business and the
principal office of the designated
examining authority for said broker or
dealer. Two copies of said report shall
be filed at the Commission’s principal
office in Washington, DC. Copies thereof
shall be provided to all self-regulatory
organizations of which said broker or
dealer is a member.’’ The Commission
proposed to delete this paragraph
because the same provisions are in
paragraph (d)(6) of Rule 17a–5.459 The
458 See
SIFMA Letter.
Broker-Dealer Reports, 76 FR at 37593. As
discussed above in section II.B.6. of this release, the
Commission is amending paragraph (d)(6) of Rule
17a–5 to require that a copy of a broker-dealer’s
annual report must be filed with SIPC. Specifically,
the Commission is amending paragraph (d)(6) to
provide that a broker-dealer’s annual reports ‘‘must
be filed at the regional office of the Commission for
the region in which the broker or dealer has its
principal place of business, the Commission’s
principal office in Washington, DC, the principal
office of the designated examining authority for the
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459 See
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Commission received no comments on
this proposal and is deleting paragraph
(b)(6) of Rule 17a–5 as proposed.
ii. Deletion of Provisions Relating to the
Year 2000
Before today’s amendments,
paragraph (e)(5) of Rule 17a–5 required
broker-dealers to file Form BD–Y2K.
Form BD–Y2K elicited information with
respect to a broker-dealer’s readiness for
the year 2000 and any potential
problems that could arise with the
advent of the new millennium.460 Form
BD–Y2K was required to be filed in
April 1999 and only then. In the
proposing release, the Commission
proposed to delete paragraph (e)(5) of
Rule 17a–5 in its entirety because the
provisions of that paragraph are now
moot.461 The Commission received no
comments on this proposal and is
deleting paragraph (e)(5) of Rule 17a–5
as proposed.
iii. Deletion of Paragraph (i)(5) of Rule
17a–5
In the proposing release, the
Commission proposed to delete
paragraph (i)(5) of Rule 17a–5, which,
before today’s amendments, provided
that ‘‘the terms audit (or examination),
accountant’s report, and certified shall
have the meanings given in § 210.1–02
of this chapter.’’ 462 The Commission
received no comments on this proposal
and is deleting paragraph (i)(5) of Rule
17a–5 as proposed.
iv. Amendments to Paragraph (f)(2) of
Rule 17a–5
Before today’s amendments,
paragraph (f)(2) of Rule 17a–5 provided
that a broker-dealer that was required to
file an annual audit report must file a
statement with the Commission and its
DEA that it has designated an
independent public accountant
responsible for performing the annual
audit of the broker-dealer, which was
called ‘‘Notice pursuant to Rule 17a–
5(f)(2)’’.463 Paragraph (f)(2)(iii) of Rule
17a–5 prescribed the items that were
required to be included in the notice:
the name, address, telephone number
and registration number of the brokerdealer; the name, address and telephone
broker or dealer, and with the Securities Investor
Protection Corporation (‘SIPC’) if the broker or
dealer is a member of SIPC. Copies of the reports
must be provided to all self-regulatory organizations
of which the broker or dealer is a member, unless
the self-regulatory organization by rule waives this
requirement.’’
460 See Reports to be Made by Certain Brokers and
Dealers, Exchange Act Release No. 40608 (Oct. 28,
1998), 63 FR 59208 (Nov. 3, 1998).
461 See Broker-Dealer Reports, 76 FR at 37593.
462 Id. at 37594.
463 See 17 CFR 240.17a–5(f)(2).
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number of the accounting firm; and the
audit date of the broker-dealer for the
year covered by the agreement.464
In addition to the proposed
amendments discussed below in section
III. of this release, the Commission
proposed certain technical amendments
to paragraph (f)(2) of Rule 17a–5.465
First, the Commission proposed
amending the language in paragraph
(f)(2)(i) of Rule 17a–5 to streamline the
paragraph and to add a reference to
proposed paragraph (f)(2)(ii) of Rule
17a–5, which would have prescribed the
information a broker-dealer would have
been required to include in its notice
designating its accountant. In addition,
the Commission proposed to amend
paragraph (f)(2)(i) of Rule 17a–5 to
require that a broker-dealer include a
statement in its notice as to whether the
engagement with its independent public
accountant was for a single year or was
of a continuing nature. This statement
was previously required by paragraph
(f)(2)(ii) of Rule 17a–5, which the
Commission proposed to delete as part
of its revisions to that paragraph. The
Commission did not receive any
comments on these proposed changes
and is adopting them as proposed. The
Commission also proposed to retain the
annual December 10 filing deadline for
the statements provided pursuant to
paragraph (f)(2), but also added the
language ‘‘(or 30 calendar days after the
effective date of its registration as a
broker or dealer, if earlier).’’ The
Commission did not receive any
comments on this amendment and is
adopting it as proposed. In addition, the
final rule adds a conforming change to
the date of the statement designating the
independent public accountant. Under
the proposal, the statement must be
dated ‘‘no later than December 1.’’
Under the final rules, the statement
must be dated ‘‘no later than December
1 (or 20 calendar days after the effective
date of its registration as a broker or
dealer, if earlier)’’ to make the timing
consistent with the filing deadlines
described above.
As discussed in the proposing release,
notices pursuant to paragraph (f)(2) of
Rule 17a–5 currently on file with the
Commission do not contain the
representations that are required by the
amendments to paragraph (f)(2) that the
Commission is adopting today.
Accordingly, broker-dealers subject to
paragraph (f)(2) of Rule 17a–5 (i.e., all
broker-dealers that are required to file
audited annual reports) must file a new
‘‘statement regarding the independent
464 See
17 CFR 240.17a–5(f)(2)(iii)(A)–(C).
Broker-Dealer Reports, 76 FR at 37583–
37584, 37605–37606.
465 See
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public accountant under Rule 17a–
5(f)(2).’’ 466 As specified in the new rule,
if the engagement covered by the new
statement is of a continuing nature, no
subsequent filing would be required
unless and until the broker-dealer
changes its independent public
accountant or amends the engagement
with the accountant.467
v. Further Technical Amendments
In the proposing release, the
Commission proposed additional
technical amendments to Rule 17a–5,
including changes that would
consistently use the term ‘‘independent
public accountant’’ throughout Rule
17a–5 when referring to a brokerdealer’s accountant,468 to make the rule
gender neutral,469 and to replace the
term ‘‘balance sheet’’ with the term
‘‘Statement of Financial Condition’’ in
all places where that term appeared in
Rule 17a–5.470 These technical
amendments were designed to
modernize the language of Rule 17a–5,
and to make the rule easier to
understand. The Commission received
no comments on these amendments and
is adopting them as proposed.
The Commission is making further
technical amendments that are
consistent with the Commission’s
‘‘plain English’’ initiative and do not
substantively affect the requirements of
Rule 17a–5.471 In addition, for clarity
and consistency throughout Rule 17a–5,
the Commission is amending Rule 17a–
5 to replace the words ‘‘date selected for
the annual audit of financial
statements’’ that were previously
contained in paragraphs (a)(2)(ii) and
(iii) of Rule 17a–5 with the words ‘‘end
of the fiscal year of the broker or
dealer.’’ 472 The phrase ‘‘date selected
for the annual audit of the financial
statements’’ has the same meaning as
the phrase ‘‘end of the fiscal year of the
broker or dealer.’’ As discussed earlier,
this change eliminates outdated
language and conforms the text in
paragraph (a) of Rule 17a–5 to the text
in paragraph (n) of Rule 17a–5. The
Commission is making a technical
amendment to paragraph (a)(3) of Rule
17a–5. As proposed, paragraph (a)(3)
466 See
paragraph (f)(2) of Rule 17a–5.
paragraph (f)(2)(i) of Rule 17a–5.
468 See Broker-Dealer Reports, 76 FR at 37594.
469 Id.
470 Id. at 37593.
471 These amendments replace the term ‘‘shall’’
with ‘‘must,’’ the term ‘‘pursuant to’’ with ‘‘under,’’
the term ‘‘said’’ with ‘‘the’’ or ‘‘that,’’ the term
‘‘such’’ with ‘‘the’’ or ‘‘that,’’ the term ‘‘other than’’
with ‘‘not,’’ and the term ‘‘therewith’’ with ‘‘with
the.’’
472 For example, 17 CFR 240.17a–5(a)(5),
(d)(3)(i)(B), and (d)(5) each refer to the ‘‘end of the
fiscal year of the broker or dealer.’’
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provided that the reports required under
paragraph (a) of Rule 17a–5 were
considered filed when received at the
Commission’s principal office and the
regional office of the Commission where
the broker-dealer has its principal place
of business. However, Form Custody,
which broker-dealers must file under
paragraph (a)(5) of Rule 17a–5, as
amended, must be filed with the brokerdealer’s DEA and not with the
Commission. The Commission is
therefore amending paragraph (a)(3) of
Rule 17a–5 to clarify that this provision
applies to reports ‘‘that must be filed
with the Commission.’’ As a result, the
Commission is making technical
amendments to paragraphs (a)(2)(i)
through (a)(2)(iv) of Rule 17a–5 to
specify that the FOCUS Reports
required under these provisions must be
filed with the Commission.
The Commission also is making
technical amendments to paragraph
(m)(1) of Rule 17a–5, which relates to
extensions and exemptions for filing
annual reports, and (n)(2) of Rule 17a–
5, which relates to a broker-dealer’s
notification requirements when
changing its fiscal year, to replace the
words ‘‘annual audit reports’’ and
‘‘audit report,’’ respectively, with the
words ‘‘annual reports.’’ The
Commission also is deleting an
unnecessary citation to paragraph
(d)(1)(i) of Rule 17a–5 that was
previously included in paragraph (n)(2)
of Rule 17a–5.
H. Coordination With Investment
Advisers Act Rule 206(4)–2
1. Background
The amendments to Rule 17a–5 that
the Commission is adopting today will
permit carrying broker-dealers that
either also are registered as investment
advisers or maintain client assets of an
affiliated investment adviser and are
subject to the internal control report
requirement in Rule 206(4)–2 to satisfy
that requirement with a report prepared
by the broker-dealer’s independent
public accountant based on an
examination of certain of the brokerdealer’s statements in the compliance
report.
2. Rule 206(4)–2
Rule 206(4)–2 provides that a
registered investment adviser is
prohibited from maintaining custody of
client funds or securities unless a
‘‘qualified custodian’’ maintains those
funds and securities: (1) In a separate
account for each client under that
client’s name; or (2) in accounts that
contain only the investment adviser’s
clients’ funds and securities, under the
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51943
investment adviser’s name as agent or
trustee for the clients.473 Under Rule
206(4)–2, only banks, certain savings
associations, registered broker-dealers,
FCMs, and certain foreign financial
institutions may act as qualified
custodians.474
In addition, when an investment
adviser or its related person maintains
client funds and securities as qualified
custodian in connection with advisory
services provided to clients, the adviser
annually must obtain, or receive from its
related person, a written internal control
report prepared by an independent
public accountant registered with, and
subject to regular inspection by, the
PCAOB.475 This report must be
supported by the independent public
accountant’s examination of the
qualified custodian’s custody
controls.476
The Commission has issued guidance
identifying the control objectives that
should be included in the scope of the
internal control examination required
under Rule 206(4)–2.477 The control
objectives for the Rule 206(4)–2
examination are more general than the
specific operational requirements in the
473 See
474 See
17 CFR 275.206(4)–2(a)(1)(i)–(ii).
17 CFR 275.206(4)–2(d)(6).
475 Id.
476 Rule 206(4)–2 provides that the internal
control report must include an opinion of an
independent public accountant as to whether
controls have been placed in operation as of a
specific date, and are suitably designed and are
operating effectively to meet control objectives
relating to custodial services, including the
safeguarding of funds and securities held by either
the adviser or its related person on behalf of
advisory clients, during the year. The rule also
requires that the accountant ‘‘verify that the funds
and securities are reconciled to a custodian other
than [the adviser or its] related person.’’ See 17 CFR
275.206(4)–2.
477 See Commission Guidance Regarding
Independent Public Accountant Engagements
Performed Pursuant to Rule 206(4)–2 Under the
Investment Advisers Act of 1940, Advisers Act
Release No. 2969 (Dec. 30, 2009), 75 FR 1492 (Jan.
11, 2010) (identifying the following specified
objectives: (1) Documentation for the opening and
modification of client accounts is received,
authenticated, and established completely,
accurately, and timely on the applicable system; (2)
client transactions, including contributions and
withdrawals, are authorized and processed in a
complete, accurate, and timely manner; (3) trades
are properly authorized, settled, and recorded
completely, accurately, and timely in the client
account; (4) new securities and changes to
securities are authorized and established in a
complete, accurate and timely manner; (5)
securities income and corporate action transactions
are processed to client accounts in a complete,
accurate, and timely manner; (6) physical securities
are safeguarded from loss or misappropriation; (7)
cash and security positions are reconciled
completely, accurately and on a timely basis
between the custodian and depositories; and (8)
account statements reflecting cash and security
positions are provided to clients in a complete,
accurate and timely manner).
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financial responsibility rules.478 This
approach allows different types of
qualified custodians (banks, certain
savings associations, broker-dealers,
FCMs, and certain foreign financial
institutions) to establish controls and
procedures that meet the identified
control objectives in a manner that
reflects differences in business models,
regulatory requirements, and other
factors.479
3. Broker-Dealers Acting as Qualified
Custodians Under Rule 206(4)–2
Broker-dealers that also are registered
as investment advisers may, acting in
their capacity as broker-dealers,
maintain client securities and funds as
qualified custodians in connection with
advisory services provided to clients.480
As a result of being the adviser and
qualified custodian to its clients, under
Rule 206(4)–2 these broker-dealers must
obtain an internal control report relating
to the custody of those assets from an
independent public accountant that is
registered with, and subject to regular
inspection by, the PCAOB. In addition,
broker-dealers acting as qualified
custodians also may maintain advisory
client assets in connection with
advisory services provided by related or
affiliated investment advisers. Rule
206(4)–2 requires such a broker-dealer
to provide an internal control report to
its related investment adviser.481
4. Proposal to Allow Report Based on
Examination of Compliance Report to
Satisfy Rule 206(4)–2
i. The Proposal
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Broker-dealers that maintain custody
of customer funds and securities are
subject to specific operational
requirements in the financial
responsibility rules with respect to
handling and accounting for customer
478 Compare the control objectives described in
Commission Guidance Regarding Independent
Public Accountant Engagements Performed
Pursuant to Rule 206(4)–2 Under the Investment
Advisers Act of 1940, 75 FR at 1494, with the
requirements in 17 CFR 240.15c3–1, 17 CFR
240.15c3–3, 17 CFR 240.17a–13, and the DEA
Account Statement Rules.
479 See Broker-Dealer Reports, 76 FR at 37580.
480 The Commission staff has estimated that
approximately 18% of FINRA-registered brokerdealers also are registered as investment advisers
with the Commission or with a state. See
Commission staff, Study on Investment Advisers
and Broker-Dealers, as required by Section 913 of
the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Jan. 2011).
481 See 17 CFR 275.206(4)–2(a)(6). Based on data
collected from the Investment Adviser Registration
Depository as of August 2012, close to 200
investment advisers reported on Form ADV that
client assets were being held at a qualified
custodian that was related to the adviser.
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assets.482 The operational requirements
of the financial responsibility rules are
consistent with the control objectives
outlined in the Commission’s guidance
on Rule 206(4)–2.483 As a result of the
proposed amendments to Rule 17a–5,
the Commission stated in the proposing
release that a broker-dealer subject to an
examination by an independent public
accountant of its compliance report that
also acts as a qualified custodian for
itself as an investment adviser or for its
related investment advisers under Rule
206(4)–2 would be able to use the
independent public accountant’s report
resulting from the examination to satisfy
the internal control report requirement
under Rule 206(4)–2.484
ii. Comments on the Proposal
The Commission received several
comments regarding the proposal that
the independent public accountant’s
report based on an examination of the
compliance report would satisfy the
internal control report under Rule
206(4)–2. One commenter stated that it
is ‘‘critically important’’ that there be a
single independent public accountant
engagement of the custody function at
both the broker-dealer and investment
adviser operations of any dually
registered entity (or of affiliated brokerdealers and investment advisers) and
that this engagement use a single,
consistent standard for evaluating
custody at both the broker-dealer and
investment adviser operations.485 Two
commenters noted that there are noncarrying broker-dealers that act as
qualified custodians under the Advisers
Act and that these broker-dealers would
not be subject to the proposed
compliance report requirements and,
consequently, would not be able to use
the report of the independent public
accountant covering the compliance
report to satisfy the internal control
report requirement in Rule 206(4)–2
because the broker-dealers would be
filing exemption reports instead of
compliance reports.486 One commenter
characterized this as an area of
redundancy that could be eliminated by
482 While Rule 15c3–1 prescribes broker-dealer
net capital requirements, it also contains provisions
relating to custody. For example, a broker-dealer
must take net capital charges for short security
differences unresolved after specifically
enumerated timeframes. See 17 CFR 240.15c3–
1(c)(2)(v)(A).
483 See Broker-Dealer Reports, 76 FR at 37579–
37580; Commission Guidance Regarding
Independent Public Accountant Engagements
Performed Pursuant to Rule 206(4)–2 Under the
Investment Advisers Act of 1940, 75 FR at 1493–
1494.
484 See Broker-Dealer Reports, 76 FR at 37579–
37580.
485 See CFP Letter.
486 See CAI Letter; Deloitte Letter.
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allowing an accountant’s review of a
non-carrying broker-dealer’s transmittal
procedures to be ‘‘recognized by the
Investment Adviser regulatory regime
promulgated by the Commission.’’ 487
In addition, two commenters asked
for clarification regarding the
interaction of the proposed compliance
report requirements with the
requirement in Rule 206(4)–2 that
investment advisers undergo an annual
surprise examination by an independent
accountant to verify customer funds and
securities held in custody.488
Specifically, both asked that the
Commission clarify whether the
independent public accountant
performing the surprise examination
would be able to place reliance on the
proposed compliance report and related
compliance examination to determine
the nature and extent of the procedures
for the surprise examination.489 One of
the commenters also asked that, if the
Commission clarifies that the
independent public accountant
performing the surprise examination is
expected to rely on the proposed
compliance report requirements, what
factors should the independent public
accountant consider, given that the
report based on an examination of the
compliance report would not be
required to be completed until 60 days
after the fiscal year end while the
surprise examination may occur at any
time.490
5. Adoption of Proposal Relating to Rule
206(4)–2
As discussed above, under today’s
amendments, a carrying broker-dealer
must prepare, and file with the
Commission and its DEA, a compliance
report on, among other things, its
Internal Control Over Compliance, and
must file with the compliance report a
report prepared by its independent
public accountant based on an
examination of the compliance
report.491 As a result of the amendments
to Rule 17a–5, the Commission has
determined that the independent public
accountant’s report based on an
examination of the compliance report
487 See
Deloitte Letter.
CAQ Letter; PWC Letter. Paragraph (a)(4)
of Rule 206(4)–2 requires, among other things, that
client funds and securities of which an investment
adviser has custody must be verified by actual
examination at least once during each calendar year
by an independent public accountant, pursuant to
a written agreement between the investment adviser
and the accountant, at a time that is chosen by the
accountant without prior notice or announcement
to the investment adviser and that is irregular from
year to year. See 17 CFR 275.206(4)–2.
489 See CAQ Letter; PWC Letter.
490 See PWC Letter.
491 See 17 CFR 240.17a–5(d)(3) and (g)(2)(i).
488 See
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will satisfy the internal control report
requirement under Rule 206(4)–2
because the operational requirements of
the financial responsibility rules are
consistent with the control objectives
outlined in the Commission’s guidance
on Rule 206(4)–2.492 For example, to be
able to include a statement that the
broker-dealer has established and
maintained Internal Control Over
Compliance (which is defined as
internal controls that have the objective
of providing the broker-dealer with
reasonable assurance that noncompliance with the financial
responsibility rules will be prevented or
detected on a timely basis),493 a brokerdealer’s internal control over
compliance with Rule 17a–13 will result
in controls over the safeguarding of
securities from loss or misappropriation
and the completeness, accuracy, and
timeliness of the securities
reconciliation process.494 To make a
similar statement with respect to the
Account Statement Rules, a brokerdealer would of necessity have internal
controls over compliance with the
Account Statement Rules designed to
ensure that customers receive complete,
accurate, and timely information
concerning securities positions and
other assets held in their accounts.495 A
492 See Commission Guidance Regarding
Independent Public Accountant Engagements
Performed Pursuant to Rule 206(4)–2 Under the
Investment Advisers Act of 1940, 75 FR at 1494;
Broker-Dealer Reports, 76 FR at 37579–37580. As
discussed above in section II.D.3. of this release, the
independent public accountant must examine the
compliance report in accordance with attestation
standards promulgated by the PCAOB.
Consequently, the PCAOB’s attestation standards
are integral to the Commission’s determination that
the independent public accountant’s report based
on an examination of the compliance report
satisfies the internal control report requirement
under Rule 206(4)–2. The Commission could revisit
this determination if the PCAOB’s attestation
standards do not support the determination.
493 See paragraphs (d)(3)(i)(A)(1) and (d)(3)(ii) of
Rule 17a–5.
494 See 17 CFR 240.17a–13. As discussed above in
section II.D.3. of this release, the PCAOB proposed
attestation standards related to the compliance
report. The PCAOB’s proposed attestation standards
include a requirement that the independent public
accountant must perform procedures to obtain
evidence about the existence of customer funds or
securities held for customers, e.g., confirmation of
customer security positions directly with
depositories and clearing organizations. See PCAOB
Proposing Release app. 1, at ¶ 26. This procedure
would be consistent with the tests of the qualified
custodian’s reconciliation that the Commission
specified in the guidance on Rule 206(4)–2. See
Commission Guidance Regarding Independent
Public Accountant Engagements Performed
Pursuant to Rule 206(4)–2 Under the Investment
Advisers Act of 1940, 75 FR 1494.
495 See, e.g., CBOE Rule 9.12; NASD Rule 2340.
See also Commission Guidance Regarding
Independent Public Accountant Engagements
Performed Pursuant to Rule 206(4)–2 Under the
Investment Advisers Act of 1940, Advisers Act
Release No. 2969 (Dec. 30, 2009), 75 FR 1494 (Jan.
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statement that the broker-dealer has
established and maintained Internal
Control Over Compliance would cover
these and other internal controls over
compliance with the financial
responsibility rules and would be
examined by the independent public
accountant during the examination of
the compliance report.
As commenters noted, broker-dealers
that are not carrying broker-dealers are
not subject to the compliance report
requirements and, therefore, those
broker-dealers must comply with the
internal control report requirement in
Rule 206(4)–2 if they are subject to that
requirement. The exemption report is
not redundant of the internal control
report requirement in Rule 206(4)–2
because, among other things, the scope
of the required statements included in a
broker-dealer’s exemption report is
different than the scope of the internal
control report requirement in Rule
206(4)–2.496
As noted above, commenters also
asked whether the accountant would be
able to place reliance on the proposed
compliance report and related
examination of the compliance report to
determine the nature and extent of the
procedures for the surprise examination.
PCAOB attestation standards require an
independent public accountant ‘‘to
obtain an understanding of internal
control over compliance sufficient to
plan the engagement and to assess
control risk for compliance with
specified requirements.’’ 497 The
Commission agrees that the
independent public accountant’s
understanding of internal controls
related to custody at the broker-dealer
acting as a qualified custodian, as well
as other facts and circumstances, may
affect the nature and extent of
procedures performed for the annual
surprise examination.498 The
Commission has provided interpretive
guidance on the relationship between
the annual surprise examination and the
11, 2010), which describes as a control objective for
qualified custodians (including broker-dealer
qualified custodians) that account statements
reflecting cash and security positions are provided
to clients in a complete, accurate and timely
manner.
496 See supra notes 299, 300.
497 See PCAOB Interim Attestation Standard, AT
Section 601. AT Section 601 requires an
independent public accountant ‘‘to obtain an
understanding of internal control over compliance
sufficient to plan the engagement and to assess
control risk for compliance with specified
requirements. In planning the examination, such
knowledge should be used to identify types of
potential non-compliance, to consider factors that
affect the risk of material noncompliance, and to
design appropriate tests of compliance.’’ Id. at ¶ .45.
498 Id.
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51945
internal control report for engagements
performed pursuant to Rule 206(4)–2.499
III. Access to Accountant and Audit
Documentation
The Commission proposed amending
paragraph (f)(2) of Rule 17a–5 to require
that each clearing broker-dealer 500
include a representation in its statement
regarding its independent public
accountant that the broker-dealer agrees
to allow Commission and DEA
examination staff to review the audit
documentation associated with its
annual audit reports required under
Rule 17a–5 and to allow its independent
public accountant to discuss findings
relating to the audit reports with
Commission and DEA examination staff
if requested for the purposes of an
examination of the broker-dealer.501
This proposed requirement was
intended to facilitate examinations of
clearing broker-dealers by Commission
and DEA examination staff.502 Access to
information obtained from audit
documentation and discussions with a
clearing broker-dealer’s independent
public accountant would enhance the
efficiency and effectiveness of
Commission and DEA examinations by
providing examiners with access to
additional relevant information to plan
their examinations.503
The Commission proposed to limit
this requirement to clearing brokerdealers, which generally have more
complex business operations than noncarrying firms.504 Thus, access to
accountants and audit documentation
was considered of substantially greater
value when preparing for regulatory
examinations of these types of brokerdealers, as compared to firms with more
limited business models.
To facilitate Commission and DEA
examination staff access to a clearing
broker-dealer’s independent public
accountant and the accountant’s audit
documentation, the Commission
proposed amending paragraph (f)(2) of
499 See Commission Guidance Regarding
Independent Public Accountant Engagements
Performed Pursuant to Rule 206(4)–2 Under the
Investment Advisers Act of 1940, Advisers Act
Release No. 2969 (Dec. 30, 2009), 75 FR 1492 (Jan.
11, 2010).
500 For the purpose of this release, a ‘‘clearing
broker-dealer’’ is a broker-dealer that clears
transactions or carries customer accounts.
501 See Broker-Dealer Reports, 76 FR at 37583–
37584.
502 Id.
503 For example, where an independent public
accountant has performed extensive testing of a
carrying broker-dealer’s custody of funds and
securities by confirming holdings at custodians and
sub-custodians, examiners could focus their efforts
on other matters that had not been the subject of
prior testing and review.
504 See Broker-Dealer Reports, 76 FR at 37583.
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Rule 17a–5 to require that a clearing
broker-dealer’s notice designating its
independent public accountant include,
among other things, representations: (1)
That the broker-dealer agrees to allow
representatives of the Commission or
the broker-dealer’s DEA, if requested for
purposes of an examination of the
broker-dealer, to review the
documentation associated with the
reports of its independent public
accountant prepared pursuant to
paragraph (g) of Rule 17a–5; and (2) that
the broker-dealer agrees to permit its
independent public accountant to
discuss with representatives of the
Commission and the DEA, if requested
for the purposes of an examination of
the broker-dealer, the findings
associated with the reports of the
accountant prepared pursuant to
paragraph (g) of Rule 17a–5.505
Proposed paragraph (f)(2)(iii) of Rule
17a–5 provided that a broker-dealer that
does not clear transactions or carry
customer accounts would not be
required to include these
representations in its notice.506
Eight commenters addressed the
proposed changes to paragraph (f)(2) of
Rule 17a–5.507 Generally, commenters
requested that the Commission do one
or more of the following: (1) Clarify the
type of documentation that the
Commission and DEA examiners would
seek to access 508; (2) grant confidential
treatment to documentation obtained by
the Commission under this
provision 509; (3) clarify the process by
which Commission and DEA examiners
would seek access to a broker-dealer’s
independent public accountant and its
audit documentation 510; and (4) limit
the use of information and
documentation obtained from a brokerdealer’s independent public
accountant.511 In addition, one
commenter raised general concerns that
providing Commission and DEA
examiners with access to a brokerdealer’s auditor and audit
documentation will discourage
communications between broker-dealers
and their auditors and may require
auditors to produce documentation
protected by attorney-client and/or
accountant-client privilege.512 Finally,
505 Id.
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506 Id.
507 See CAI Letter; CAQ Letter; CFP Letter;
Deloitte Letter; E&Y Letter; KPMG Letter; PWC
Letter; SIFMA Letter.
508 See CAQ Letter; Deloitte Letter; E&Y Letter;
KPMG Letter.
509 See CAI Letter; KPMG Letter; PWC Letter;
SIFMA Letter.
510 See Deloitte Letter; E&Y Letter; KPMG Letter.
511 See E&Y Letter; PWC Letter.
512 See CAI Letter.
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one commenter asserted that it is
reasonable for securities regulators to be
able to validate any concerns promptly
with a broker-dealer’s accountant.513
In response to requests for clarity as
to the types of audit documentation that
Commission and DEA examiners would
seek to access under the proposal, the
Commission revised proposed
paragraph (f)(2)(ii)(F) of Rule 17a–5 to
clarify that ‘‘audit documentation’’ has
the meaning established by PCAOB
standards.514 This revision, which was
specifically suggested by two
commenters,515 is not intended to alter
an independent public accountant’s
obligations with respect to audit
documentation; rather, it is intended to
clarify the types of audit documentation
that the Commission and DEA
examiners may ask to review in
connection with a broker-dealer
examination.
In response to questions regarding the
process by which Commission and DEA
examiners might seek to access audit
documentation, the Commission agrees
with a commenter that suggested that
these requests be in writing because that
will provide independent public
accountants with a record of requests for
information and specify the
documentation the Commission or DEA
examination staff would like to
access.516 Therefore, the Commission
513 See
CFP Letter.
Auditing Standard 3 defines ‘‘Audit
documentation’’ as the ‘‘written record of the basis
for the auditor’s conclusions that provides the
support for the auditor’s representations, whether
those representations are contained in the auditor’s
report or otherwise. Audit documentation also
facilitates the planning, performance, and
supervision of the engagement, and is the basis for
the review of the quality of the work because it
provides the reviewer with written documentation
of the evidence supporting the auditor’s significant
conclusions. Among other things, audit
documentation includes records of the planning
and performance of the work, the procedures
performed, evidence obtained, and conclusions
reached by the auditor. Audit documentation also
may be referred to as work papers or working
papers.’’
515 See CAQ Letter; KPMG Letter.
516 See KPMG Letter. See also Deloitte Letter,
which suggests that Commission and DEA
examiners first provide notice to the broker-dealer,
in writing, of plans to request access to the brokerdealer’s audit documentation and then make a
written request to the accountant. Although, in
practice, Commission and DEA examiners may
provide advance or simultaneous notice to a brokerdealer of requests to access audit documentation
from the broker-dealer’s accountant, the
Commission is not adopting a requirement that
examiners so notify broker-dealers of such requests.
This additional notification would likely delay an
examiner’s ability to gain access to the brokerdealer’s audit documentation and is not necessary
given the broker-dealer’s prior consent. In addition,
a broker-dealer can request that its accountant
provide notice when examiners request audit
documentation, and, expects that, in practice,
accountants will provide such notice. See also E&Y
Letter.
514 PCAOB
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has modified the rule from the proposal
to provide that a request to a brokerdealer’s independent public accountant
for the accountant to discuss audit
findings or for access to audit
documentation be made in writing.
Independent public accountants can
seek to protect information obtained by
examiners from being disclosed to
Freedom of Information Act (‘‘FOIA’’)
requestors by specifically requesting
confidential treatment of audit
documentation following the process
described in Rule 83 of the
Commission’s Rules on Information and
Requests.517 The Commission
anticipates that it will accord
confidential treatment to such
documents to the extent permitted by
law.518
Two commenters requested that the
Commission clarify the intended use of
information and documents obtained
from an independent public
accountant.519 One recommended that
the Commission clarify that the
information obtained from the
independent public accountant not be
used for any purpose other than in
connection with a regulatory
examination of the broker-dealer.520 The
other suggested that the rule text state
that the requests for information should
be solely for the purposes of conducting
a regulatory examination of the clearing
broker-dealer.521 The Commission does
not believe that it is necessary to modify
the proposed rule text in response to
these comments. The Commission
stated that it did not propose that
examiners would use the requested
information for the purpose of
inspecting independent public
accountants.522 As the Commission
stated in the proposing release, the
purpose of this access requirement is to
enhance and improve the efficiency and
effectiveness of Commission and DEA
examinations of broker-dealers.523 The
PCAOB is responsible for inspections of
independent public accountants that
audit broker-dealers.524 In response to
these comments, the Commission
reiterates its intention, as stated in the
proposing release, that any requests for
517 17 CFR 200.83. Generally, persons who submit
information to the Commission may request that the
Commission accord confidential treatment to the
information for any reason permitted by federal
law.
518 The Commission believes that this audit
documentation likely would fall under exemptions
(b)(8) and/or (b)(4) of FOIA. See 5 U.S.C. 522(b)(8);
5 U.S.C. 522(b)(4).
519 See E&Y Letter; PWC Letter.
520 See PWC Letter.
521 See E&Y Letter.
522 See Broker-Dealer Reports, 76 FR at 37583.
523 Id.
524 Id.
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audit documentation under this
provision would be made exclusively in
connection with conducting a regulatory
examination of a broker-dealer.525
One commenter stated that
Commission and DEA examiners should
be limited to inspecting audit
documentation relating to a brokerdealer in the offices of the brokerdealer’s independent public accountant
and that the broker-dealer should be
permitted to be present during
conversations between Commission or
DEA staff and the accountant.526 The
Commission has considered these
comments and decided not to modify
the proposal in response to these
comments. However, Commission and
DEA examiners may exercise discretion
in determining whether to review audit
documentation in the offices of the
broker-dealer’s accountant and whether
to permit the broker-dealer to be present
during conversations with the
accountant. This commenter also
requested that the Commission establish
a process by which broker-dealers can
object to overly broad or unduly
burdensome requests.527 The rule will
not be modified in response to this
comment and the Commission
recommends that any concerns
regarding the scope of audit
documentation requests be directed to
the examiner from whom the request
was received. The examiner will
consider the concerns and determine
whether and how to limit the scope of
the audit documentation request, if
appropriate. The independent public
accountant also can express concerns to
senior examination staff if the scope of
the audit documentation request
remains a concern after discussions
with the examiner.
Another commenter stated that the
Commission must be responsible for
returning all audit work papers that it
receives for purposes of an examination
of the broker-dealer to either the brokerdealer or its accountant.528 The purpose
of requesting access to audit
documentation is to assist examiners in
conducting a regulatory examination of
the clearing broker-dealer. Upon
completion of the examination, if the
Commission and DEA, and any offices
and divisions thereof, no longer need
the audit documentation, the
Commission and DEA will, upon the
request of the independent public
accountant and in the absence of
unusual circumstances, return audit
documentation to the independent
525 Id.
526 See
SIFMA Letter.
527 Id.
528 See
public accountant or the broker-dealer
within a reasonable time after the
examination is complete.
One commenter stated that, if
adopted, this requirement will
discourage or ‘‘chill’’ communications
between a broker-dealer and its auditor
because ‘‘the broker-dealer knows that
regardless of the nature of an auditing
issue and how it was discovered . . . it
cannot freely seek advice from, or
discuss the issue openly with[] the
auditor[] without fear of the auditor
misunderstanding the broker-dealer’s
response or simply drawing a
conclusion that a broker-dealer’s
questions indicate the broker-dealer’s
lack of knowledge or admission of an
issue.’’ 529 Presumably, this ‘‘chilling
effect’’ would result from a brokerdealer’s desire to avoid the creation of
audit documentation memorializing
misunderstandings and
miscommunications, which, when
accessed by Commission and DEA
examiners, could result in regulatory
scrutiny. The Commission is not
persuaded by this comment; while it is
possible for miscommunications to
occur between representatives of a
broker-dealer and its auditor, potential
misunderstandings or
miscommunications should not limit
the ability of the Commission or a DEA
to have access to audit documentation
or a broker-dealer’s independent public
accountant. Further, to the extent a
misunderstanding or
miscommunication between a brokerdealer and its accountant is reflected in
the accountant’s audit documentation
relating to the broker-dealer, the brokerdealer could clarify the nature of the
misunderstanding or
miscommunication to examiners and
explain how it was rectified if such
clarification and rectification is not
already described in subsequent audit
documentation.
The same commenter also asserted
that the requirement that broker-dealers
allow regulators to access audit
documentation may, in effect, require
auditors to produce documentation
protected by attorney-client privilege or
accountant-client privilege.530 The rule
language providing Commission and
DEA examiners with access to a brokerdealer’s auditor and audit
documentation is not designed to affect
the circumstances in which privilege
can be asserted. Any claims of privilege
can be addressed on a case-by-case basis
by appropriate Commission and DEA
staff as those claims arise.
529 Id.
CAI Letter.
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530 Id.
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51947
IV. Form Custody
A. Background
Proposed Form Custody was
comprised of nine line items (each, an
‘‘Item’’) designed to elicit information
about a broker-dealer’s custodial
activities.531 As is discussed below,
several Items on the proposed form
contained multiple questions, and some
required the completion of charts and
the disclosure of custody-related
information specific to the broker-dealer
completing the form.532
The Commission received nine
comment letters on proposed Form
Custody.533 While commenters
generally supported the proposed form,
the Commission received several
comments on the timing of, exemptions
from, and the compliance date for filing
the form and whether a broker-dealer
also would be required to file an
accountant’s attestation covering the
form.534 In addition, several
commenters suggested that the
Commission make certain revisions to
the form and address certain technical
interpretative questions.535 One
commenter, who agreed ‘‘in concept’’
that Form Custody is appropriate for
custodial broker-dealers, also stated that
the aggregate cost estimate of the
proposed form was ‘‘staggering.’’ 536
The Commission is adopting the
requirement that broker-dealers file
Form Custody with their DEAs, subject
to modifications that, in part, respond to
issues raised by commenters. A
description of the comments on the
proposed process for filing Form
Custody is set forth below in section
IV.B. of this release, together with a
discussion of the final rule amendments
that the Commission is adopting today.
A description of the comments on the
proposed form is set forth below in
section IV.C. of this release, together
with a discussion of the final form the
Commission is adopting today.
B. Filing of Form Custody
1. Requirement to File Form Custody
with FOCUS Reports
Under paragraph (a) of Rule 17a–5, a
broker-dealer is required to file periodic
531 See Broker-Dealer Reports, 76 FR at 37584–
37592.
532 Id.
533 See Angel Letter; Barnard Letter; CAI Letter;
CFP Letter; E&Y Letter; IMS Letter; KPMG Letter;
Shatto Letter; SIFMA Letter.
534 See CAI Letter; E&Y Letter; KPMG Letter;
Shatto Letter; SIFMA Letter.
535 See Angel Letter; CFP Letter; SIFMA Letter.
536 See IMS Letter. This commenter, however, did
not provide any suggestion for reducing the costs
associated with Form Custody. See section VII.
below for an economic analysis of the costs and
benefits relating to Form Custody.
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FOCUS Reports with the Commission
and the broker-dealer’s DEA.537 In the
proposing release, the Commission
proposed adding paragraph (a)(5) to
Rule 17a–5 to require the filing of Form
Custody, which was designed to elicit
information concerning whether a
broker-dealer maintained custody of
customer and non-customer assets, and,
if so, how such assets were
maintained.538 Under this proposed
amendment, a broker-dealer would be
required to file Form Custody with its
DEA at the same time it filed its periodic
FOCUS Report with its DEA under
paragraph (a) of Rule 17a–5.539 The
DEA, in turn, would be required to
maintain the information obtained
through the filing of Form Custody and
to transmit such information to the
Commission at such time as it transmits
FOCUS Report data to the Commission
under paragraph (a)(4) of Rule 17a–5.540
A broker-dealer’s FOCUS Report
provides the Commission and a brokerdealer’s DEA with information relating
to the broker-dealer’s financial and
operational condition but does not
solicit detailed information on how a
broker-dealer maintains custody of
assets.541 Proposed Form Custody was
intended to provide additional
information about a broker-dealer’s
custodial activities and to make it easier
for examiners to identify risks and
possible violations of laws and
regulations concerning the brokerdealer’s custody of assets.542 If, upon
reviewing Form Custody, regulatory
authorities were to become aware of
inconsistencies or other red flags in
information contained on the form, they
could initiate a more focused and
537 See 17 CFR 240.17a–5(a); 17 CFR 249.617.
FOCUS Reports are one of the primary means of
monitoring the financial and operational condition
of broker-dealers and enforcing the broker-dealer
financial responsibility rules. The completed forms
also are used to determine which firms are engaged
in various securities-related activities and how
economic events and government policies might
affect various segments of the securities industry.
The FOCUS Report was designed to eliminate
overlapping regulatory reports required by various
SROs and the Commission and to reduce reporting
burdens as much as possible. FOCUS Reports and
Form Custody are deemed confidential under
paragraph (a)(3) of Rule 17a–5.
538 See Broker-Dealer Reports, 76 FR at 37592. For
purposes of Form Custody, the term ‘‘customer’’
means a person that is a ‘‘customer’’ for purposes
of Rule 15c3–3(a), and a ‘‘non-customer’’ means a
person other than a ‘‘customer’’ as that term is
defined in Rule 15c3–3(a). See 17 CFR 240.15c3–
3(a); FINRA, Interpretations of Financial and
Operational Rules, Rule 15c3–3(a)(1)/01, available
at https://www.finra.org/Industry/Regulation/
Guidance/FOR/.
539 See Broker-Dealer Reports, 76 FR at 37592.
540 Id.
541 See Form X–17A–5 Schedule I, Part II, Part IIa,
Part IIb, and Part III.
542 See Broker-Dealer Reports, 76 FR at 37585.
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detailed analysis of the broker-dealer’s
custodial activities. Such an analysis
could, in turn, identify potential abuses
related to customer assets. Moreover,
proposed Form Custody was intended to
expedite the examination of a brokerdealer’s custodial activities and reduce
examination costs, as examiners would
no longer need to request basic custodyrelated information already disclosed on
the form.543
The Commission proposed that a
broker-dealer file Form Custody with its
DEA within 17 business days after the
end of each calendar quarter and within
17 business days after the date selected
for the broker-dealer’s annual report
where that date was other than the end
of a calendar quarter.544 The
Commission received one comment
regarding proposed paragraph (a)(5) of
Rule 17a–5, which supported the
Commission’s proposal as to when a
broker-dealer should be required to file
Form Custody.545
The Commission is adopting
paragraph (a)(5) of Rule 17a–5
substantially as proposed. As to when a
broker-dealer must file its Form Custody
with its DEA, the Commission is
adopting its proposal that a brokerdealer file Form Custody with its DEA
within 17 business days after the end of
each calendar quarter.546 However, for
year end filings of Form Custody by a
broker-dealer that has selected a fiscal
year end date that is not the end of a
calendar year, the Commission has
modified its proposal to provide that a
broker-dealer also must file Form
Custody with its DEA within 17
business days after the end of the
broker-dealer’s fiscal year.547
The Commission did not receive any
comments relating to when DEAs are
required to transmit Form Custody
information to the Commission and is
adopting this requirement as proposed.
2. Requests for Exemption From Filing
Form Custody
One commenter recommended that
the Commission include a provision in
Rule 17a–5 that would enable the
543 Id.
544 Id.
at 37592.
Shatto Letter.
546 See paragraph (a)(5) of Rule 17a–5.
547 Id. Consistent with the proposal, a brokerdealer must file Form Custody with its DEA at the
same time that the broker-dealer files its FOCUS
Report with its DEA. However, since the final rule
changes the date for the filing of the year end
FOCUS Report to ‘‘within 17 business days after the
end of the fiscal year where that date is not the end
of a calendar quarter,’’ the deadline for the year end
filing of Form Custody is correspondingly changed
to ‘‘within 17 business days after the end of the
fiscal year of the broker or dealer where that date
is not the end of a calendar quarter.’’
545 See
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Commission to exempt broker-dealers
from the requirement to file Form
Custody if the Commission determined
that receiving the form for a particular
firm, or type of firm, would serve no
useful purpose.548 For example, the
commenter stated that no useful
purpose would be served by receiving
Form Custody from a firm that has no
customer or non-customer accounts.549
The Commission intends for all
broker-dealers to file Form Custody
without exception. The Commission is
concerned about circumstances where
broker-dealers falsely represent to
regulators and others that they do not
handle funds or securities or issue trade
confirmations or account statements.
One of the purposes of Form Custody is
to assist Commission and DEA
examiners in identifying potential
misrepresentations relating to brokerdealers’ custody of assets. Through
Form Custody, examiners will be in a
position to better understand a brokerdealer’s custody profile and identify
custody-related violations and
misconduct. For example, if a brokerdealer represents on Form Custody that
it does not issue account statements, but
an examiner receives an account
statement issued by the broker-dealer
(e.g., in connection with a customer
complaint or in the course of an
examination of the broker-dealer), the
examiner will be able to react more
quickly to the misrepresentation.
Further, the requirements to file the
form will promote greater focus and
attention to custody practices by
requiring that broker-dealers make
specific representations in this regard.
In addition, although the Commission
does not currently contemplate any
circumstance in which it would exempt
a broker-dealer from having to file Form
Custody, if the Commission
subsequently determines that it is
appropriate to exempt a broker-dealer,
or type of broker-dealer, from such
requirements, the Commission can act
under existing authority. In particular,
under section 36 of the Exchange Act,
the Commission, by rule, regulation, or
order, may exempt any person, or any
class or classes of persons, from any rule
under the Exchange Act to the extent
that such exemption is necessary or
appropriate in the public interest and is
consistent with the protection of
investors.550
Nonetheless, the Commission
understands that a number of Items on
Form Custody may not apply to certain
types of broker-dealers (e.g., broker548 See
CAI Letter.
549 Id.
550 15
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dealers that do not carry customer, noncustomer, or proprietary securities
accounts) and has modified the form’s
instructions to make clear that questions
on the form that cannot be answered
because the broker-dealer does not
engage in a particular activity do not
need to be answered.551
3. Attest Engagement Not Required for
Form Custody
In response to a question posed by the
Commission in the proposing release,
one commenter stated that the
Commission should not require a
broker-dealer to engage a PCAOBregistered independent public
accountant to audit Form Custody.552
This commenter stated that an audit of
Form Custody is not necessary since the
intent of the form is to gather custodyrelated information, which in some
cases may not be derived from the
broker-dealer’s books and records.553
This commenter also does not believe
that the benefits of performing an audit
of the information included on Form
Custody would outweigh the costs or
that an audit is necessary for the
Commission to achieve its principal
objective of using the information in the
examination of a broker-dealer’s custody
activities.554
The Commission did not propose to
require that a broker-dealer engage an
independent public accountant to
review Form Custody, and agrees that
such a requirement should not be
imposed. Accordingly, under today’s
amendments, broker-dealers are not
required to enter into an attestation
engagement with an independent public
accountant for purposes of reviewing
Form Custody.
C. Form Custody
As is discussed above, proposed Form
Custody was comprised of nine Items
designed to elicit information about a
broker-dealer’s custodial activities. Set
forth below is a description of each of
the Items.
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1. Item 1—Accounts Introduced on a
Fully Disclosed Basis
Item 1 consists of two subparts. Item
1.A, as proposed, would have elicited
information concerning whether the
broker-dealer introduced customer
accounts to another broker-dealer on a
fully disclosed basis by requiring the
broker-dealer to check the appropriate
551 See
General Instruction A to Form Custody.
KPMG Letter. See also Broker-Dealer
Reports, 76 FR at 37592.
553 See KPMG Letter.
554 Id.
552 See
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‘‘Yes’’ or ‘‘No’’ box.555 Item 1.B of Form
Custody would require broker-dealers
that check ‘‘Yes’’ on Item 1.A to identify
each broker-dealer to which customer
accounts are introduced on a fully
disclosed basis.556 The Commission did
not receive any comments on Item 1.A
or 1.B and is adopting this Item as
proposed.
As is discussed in the proposing
release, many broker-dealers enter into
agreements (‘‘carrying agreements’’)
with another broker-dealer in which the
two firms allocate certain
responsibilities with respect to the
handling of accounts.557 These carrying
agreements are governed by applicable
SRO rules, which require a brokerdealer entering into a carrying
agreement to allocate certain
responsibilities associated with
introduced accounts.558
Typically, under a carrying
agreement, one broker-dealer
(‘‘introducing broker-dealer’’) agrees to
act as the customer’s account
representative (e.g., by providing the
customer with account opening
documents, ascertaining the customer’s
investment objectives, and making
investment recommendations). The
carrying broker-dealer typically agrees
to receive and hold the customer’s cash
and securities, clear transactions, make
and retain records relating to the
transactions and the receipt and holding
of assets, and extend credit to the
customer in connection with the
customer’s securities transactions.
Item 1.A, as adopted, elicits
information concerning whether the
broker-dealer introduces customer
accounts to another broker-dealer on a
fully disclosed basis, rather than asking
whether the broker-dealer is an
‘‘introducing broker-dealer.’’ The
Commission is presenting the question
in this manner because some brokerdealers operate as carrying brokerdealers (i.e., they hold cash and
securities) for one group of customers
but also introduce the accounts of a
second group of customers on a fully
disclosed basis to another broker-dealer.
For example, a broker-dealer may incur
the capital expense and cost of acting as
a carrying broker-dealer for certain
products (e.g., equities) but not for other
products (e.g., options). In this case, the
555 See Broker-Dealer Reports, 76 FR at 37585.
See AICPA Broker-Dealer Audit Guide glossary
(defining the term fully disclosed basis as a
‘‘situation in which a nonclearing broker introduces
a customer to a clearing broker and the customer’s
name and statement are carried by, and disclosed
to, that clearing broker.’’).
556 See Broker-Dealer Reports, 76 FR at 37585.
557 Id.
558 See, e.g., FINRA Rule 4311.
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51949
firm operates as a hybrid introducing/
carrying broker-dealer by introducing on
a fully disclosed basis to a carrying
broker-dealer those customers that trade
securities for which the broker-dealer is
not prepared to provide a full range of
services. Broker-dealers also may
introduce customer accounts on an
omnibus basis, as is discussed below in
section IV.C.2. of this release.
If the broker-dealer answers Item 1.A
by checking the ‘‘Yes’’ box, the brokerdealer will be required under Item 1.B
to identify each broker-dealer to which
customer accounts are introduced on a
fully disclosed basis. The carrying
broker-dealer in such an arrangement
maintains the cash and securities of the
introduced customers and is therefore
obligated to return cash and securities to
the introduced customers. Commission
and DEA examiners could use the
identification information provided by a
broker-dealer in response to Item 1.B to
confirm the existence of an introducing/
carrying relationship.
2. Item 2—Accounts Introduced on an
Omnibus Basis
Item 2 of Form Custody consists of
two subparts. Item 2.A, as proposed,
would have elicited information
concerning whether the broker-dealer
introduced customer accounts to
another broker-dealer on an omnibus
basis by requiring the broker-dealer to
check the appropriate ‘‘Yes’’ or ‘‘No’’
box.559 Item 2.B, as proposed, would
require a broker-dealer that checks
‘‘Yes’’ in response to Item 2.A to
identify each broker-dealer to which
customer accounts are introduced on an
omnibus basis.560 The Commission did
not receive any comments on Items 2.A
or 2.B and is adopting this Item as
proposed.
An omnibus account is an account
carried and cleared by another brokerdealer that contains accounts of
undisclosed customers on a
commingled basis and that are carried
individually on the books of the brokerdealer introducing the accounts.561
Disclosure of this information is
important because when a broker-dealer
introduces customer accounts to another
broker-dealer on an omnibus basis, the
introducing broker-dealer (in addition to
the broker-dealer carrying the omnibus
account) is considered to be a carrying
broker-dealer with respect to those
accounts under the Commission’s
broker-dealer financial responsibility
559 See Broker-Dealer Reports, 76 FR at 37585–
37586.
560 Id. at 37586.
561 See AICPA Broker-Dealer Audit Guide at ¶¶
5.144–5.145.
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rules.562 Thus, in these arrangements,
the broker-dealer introducing the
omnibus account is obligated to return
cash and securities in the account to
customers.563
If the broker-dealer checks the ‘‘Yes’’
box in Item 2.A, it will be required to
identify in Item 2.B each broker-dealer
to which accounts are introduced on an
omnibus basis. Commission and DEA
examiners could use this information to
confirm whether the cash and securities
introduced to the carrying broker-dealer
are in fact being held in an omnibus
account at the carrying broker-dealer
and that the books and records of the
broker-dealer that introduced the
customer accounts to the carrying
broker-dealer reflect the correct amounts
of customer cash and securities held in
the omnibus account.
3. Item 3—Carrying Broker-Dealers
Item 3 of Form Custody, as proposed,
would have elicited information
concerning how a carrying broker-dealer
held cash and securities.564 Proposed
Item 3 was comprised of five subparts,
as described below.565 Two commenters
specifically addressed this Item, in
particular regarding subparts 3.C., 3.D,
and 3.E, which also are discussed
below.566
i. Items 3.A and 3.B
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The first question of Item 3 of
proposed Form Custody—Item 3.A—
would have elicited information
concerning whether the broker-dealer
carried securities accounts for
customers by requiring the broker-dealer
to check the appropriate ‘‘Yes’’ or ‘‘No’’
box.567 The General Instructions to
Form Custody specify that the term
‘‘customer’’ as used in the Form means
a ‘‘customer’’ as defined in Rule 15c3–
3.
The next question of Item 3—Item
3.B—would have elicited information
concerning whether the broker-dealer
carried securities accounts for persons
that are not ‘‘customers’’ under the
definition in Rule 15c3–3.568 For
example, under Rule 15c3–3, persons
that are not ‘‘customers’’ include an
accountholder that is a general partner,
director, or principal officer of the
carrying broker-dealer, and
accountholders that are themselves
562 See Net Capital Rule, Exchange Act Release
No. 31511 (Nov. 24, 1992), 57 FR 56973, 56978 n.16
(Dec. 2, 1992).
563 Id.
564 See Broker-Dealer Reports, 76 FR at 37586.
565 Id. at 37586–37589.
566 See CFP Letter; SIFMA Letter.
567 See Broker-Dealer Reports, 76 FR at 37586.
568 Id.
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broker-dealers.569 The Commission did
not receive any comments on Item 3.A
or 3.B and is adopting these questions
as proposed.
ii. Item 3.C
a. Background
Item 3.C, as proposed, would have
required the broker-dealer to identify in
three charts the types of locations where
it held securities and the frequency with
which it performed reconciliations
between the information on its stock
record and information on the records of
those locations.570 Each of these charts,
which are set forth in Items 3.C.i
through 3.C.iii, is discussed in more
detail below.
b. General Comments to Item 3.C
One commenter suggested that it
would be helpful to require the brokerdealer to disclose the identities of
specific entities at which it custodies
securities.571 This commenter stated
that such disclosure would allow
regulators to identify potential
discrepancies more easily, as well as
changes in custody relationships that
may warrant further investigations.572
The Commission has considered this
suggestion and determined that
providing the identities of a brokerdealer’s custodians instead of the types
of locations would significantly increase
the burden on broker-dealers in
preparing the form, which is intended to
be a starting point for Commission and
DEA examiners in assessing a brokerdealer’s compliance with its custody
requirements. Large broker-dealers often
maintain custody of customers’
securities in many locations, which can
total in the hundreds, particularly if the
broker-dealer carries a large number of
uncertificated investments for
customers, such as alternative
investments. Requiring broker-dealers to
disclose this level of detail on Form
Custody could significantly increase the
costs of preparing the form for a number
of broker-dealers. Although the
Commission acknowledges that
requiring the additional information the
commenter suggested would enhance
the ability of regulators to identify
discrepancies, the Commission believes
that the information on Form Custody
provides sufficient information to allow
examiners to determine whether it is
appropriate to seek additional
information from a particular brokerdealer. To the extent a Commission or
569 See
570 See
17 CFR 240.15c3–3(a)(1).
Broker-Dealer Reports, 76 FR at 37586–
37587.
571 See CFP Letter.
572 Id.
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DEA examiner believes that it is
appropriate to obtain this information
from a particular broker-dealer, the
examiner could do so in a document
request to that firm, a method that the
Commission expects would be less
costly than requiring this information
from all broker-dealers on Form
Custody. Accordingly, the Commission
has determined not to require that
broker-dealers identify on the form the
specific identities of all of their
custodians.
Another commenter to Item 3.C
requested that the Commission clarify
the distinction between ‘‘locations
where the broker-dealer holds securities
directly in the name of the brokerdealer’’ and ‘‘locations where the
broker-dealer holds securities only
through an intermediary.’’ 573 In making
this distinction, the Commission
intended to distinguish between
locations that are aware of the identity
of the broker-dealer and act directly
upon the broker-dealer’s instructions
and locations that are not aware of the
identity of the broker-dealer or that will
not act on instructions directly from the
broker-dealer. In the latter scenario, the
location holding securities for the
broker-dealer would act only on
instructions relating to the brokerdealer’s securities from the brokerdealer’s intermediary. The Commission
has modified the instructions to Item
3.C of Form Custody to reflect this
clarification.
c. Item 3.C.i
The first chart in Item 3.C—set forth
in Item 3.C.i—identifies the most
common locations where broker-dealers
hold securities. Many of the locations
identified on the first chart, and
described below, are locations deemed
to be satisfactory control locations
under paragraph (c) of Rule 15c3–3.574
The Commission did not receive any
comments on Item 3.C.i of proposed
Form Custody and is adopting it as
proposed.
The first location identified in the
chart is the broker-dealer’s vault.
Broker-dealers primarily hold securities
in fungible bulk at other institutions. In
some cases, however, broker-dealers
may physically hold securities
certificates (e.g., in the case of restricted
securities).
The second location identified in the
chart is another U.S. registered brokerdealer. For example, a broker-dealer
may hold customers’ foreign securities
at another U.S. broker-dealer, or may
573 See
574 See
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hold securities in an omnibus account at
another broker-dealer.
The third and fourth locations
identified in the chart are the
Depository Trust Company and the
Options Clearing Corporation. These are
the two most common securities
clearing and depository organizations
for equities and options in the U.S. and,
consequently, are identified by name
rather than by type of location.
The fifth location identified in the
chart is a U.S. bank. Broker-dealers may
have arrangements with U.S. banks to
receive and hold securities for the
accounts of the broker-dealer’s
customers and non-customers, as well
as for the broker-dealer’s own account.
Obtaining information about a brokerdealer’s relationships with U.S. banks
could enable examiners to test and
confirm the accuracy of the brokerdealer’s representations on Form
Custody (i.e., that a U.S. bank holds
securities for the broker-dealer), and, in
addition, facilitate the collection of
information regarding the relationship
between the broker-dealer and the bank.
For instance, customer fully paid and
excess margin securities must be in the
possession or control of the brokerdealer and therefore cannot be pledged
as collateral for a loan to the brokerdealer, among other things, and
customer margin securities may not be
commingled with proprietary securities
that are pledged as collateral for a bank
loan. Form Custody could, for example,
lead examiners to seek account
statements and documentation
governing the broker-dealer’s
relationship with the U.S. bank to
ensure customer fully paid and excess
margin securities are not pledged as
collateral for a loan to the broker-dealer.
The sixth location identified in the
chart is the transfer agent of an openend investment management company
registered under the Investment
Company Act of 1940 (i.e., a mutual
fund). Generally, mutual funds issue
securities only in book-entry form. This
means that the ownership of securities
is not reflected on a certificate that can
be transferred but rather through a
journal entry on the books of the issuer
maintained by the issuer’s transfer
agent. A broker-dealer that holds mutual
funds for customers generally holds
them in the broker-dealer’s name on the
books of the mutual fund.
d. Item 3.C.ii
The second chart in Item 3.C—set
forth in Item 3.C.ii—is intended to
capture all other types of U.S. locations
where a broker-dealer may hold
securities that are not specified in the
chart included in Item 3.C.i. This
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category would include, for example,
securities held in book-entry form by
the issuer of the securities or the issuer’s
transfer agent. A broker-dealer that
holds securities at such locations must
list the types of locations in the spaces
provided in the chart and indicate the
frequency with which the broker-dealer
performs asset reconciliations with
those locations. The Commission did
not receive any comments on Item 3.C.ii
of proposed Form Custody and is
adopting it as proposed.
e. Item 3.C.iii
The third chart in Item 3.C—set forth
in Item 3.C.iii—pertains to foreign
locations where the broker-dealer
maintains securities. Under the
proposal, the Commission did not list
categories of foreign locations because
terminology used to identify certain
locations may differ by jurisdiction.575
For example, in some foreign
jurisdictions, banks may operate a
securities business, making it difficult to
classify whether securities are held at a
bank or a broker-dealer. A broker-dealer
that holds securities in a foreign
location must list the types of foreign
locations where it maintains securities
in the spaces provided in the chart and
indicate the frequency with which
reconciliations are performed with the
location. The Commission did not
receive any comments on Item 3.C.iii of
proposed Form Custody and is adopting
it as proposed.
iii. Items 3.D and 3.E
Items 3.D and 3.E of proposed Form
Custody each contained three identical
subparts (discussed in more detail
below) designed to elicit information
about the types and amounts of
securities and cash the broker-dealer
held, whether those securities were
recorded on the broker-dealer’s stock
record and, if not, why they were not
recorded, and where the broker-dealer
held free credit balances.576 The General
Instructions to proposed Form Custody
defined ‘‘free credit balances’’ as
liabilities of a broker-dealer to
customers or non-customers which are
subject to immediate cash payment to
customers or non-customers on demand,
whether resulting from sales of
securities, dividends, interest, deposits,
or otherwise.577
575 See
Broker-Dealer Reports, 76 FR at 37587.
at 37587–37589.
577 This definition is similar to the definition of
the term free credit balance in Rule 15c3–3, except
that the definition in the rule is limited to liabilities
to customers whereas the definition in the Form
contemplates liabilities to customers and noncustomers. See 17 CFR 240.15c3–3(a)(8).
576 Id.
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51951
The difference between proposed Item
3.D and proposed Item 3.E is that the
former would have elicited information
with respect to securities and free credit
balances held for the accounts of
customers, whereas the latter would
have elicited information with respect
to securities and free credit balances
held for the accounts of persons who are
not customers.578 Accordingly, the
proposed form asked two sets of
identical questions to elicit information
about each category of accountholder—
customer and non-customer.579
a. Items 3.D.i and 3.E.i
Items 3.D.i and 3.E.i of proposed
Form Custody would have elicited
information about the types and dollar
amounts of the securities the brokerdealer carried for the accounts of
customers and non-customers,
respectively.580 Specifically, for each
Item, the broker-dealer would have been
required to complete information on a
chart to the extent applicable.581 The
proposed charts were comprised of
twelve rows, with each row representing
a category of security. These categories
included: (1) U.S. Equity Securities; (2)
Foreign Equity Securities; (3) U.S.
Listed Options; (4) Foreign Listed
Options; (5) Domestic Corporate Debt;
(6) Foreign Corporate Debt; (7) U.S.
Public Finance Debt; (8) Foreign Public
Finance Debt; (9) U.S. Government Debt;
(10) Foreign Sovereign Debt; (11) U.S.
Structured Debt; and (12) Foreign
Structured Debt. A thirteenth row was
included in each chart to identify any
securities not specifically listed in the
first twelve rows. The types of securities
were categorized this way because the
various categories ordinarily are
associated with certain types of
locations. Thus, as examiners review the
form, they could assess whether the
types of securities held by the brokerdealer were maintained at locations
generally known to hold such securities.
If a broker-dealer’s completed form
indicated that some types of securities
were held at a location atypical for such
securities, the examiner could refine the
focus of the examination to evaluate
whether customer assets were properly
safeguarded. The Commission is
adopting these requirements, with
modifications, as discussed below.
One commenter requested that the
Commission clarify whether alternative
investments, mutual funds, and
exchange traded funds fall within the
578 See Broker-Dealer Reports, 76 FR at 37587–
37589.
579 Id.
580 Id. at 37587.
581 Id.
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scope of ‘‘Other’’ securities within the
thirteenth row of Items 3.D.i and
3.E.i.582 The Commission has
considered this comment and
determined that those investments are
other types of securities that should be
part of Items 3.D.i and 3.E.i, but that it
would be useful to separately identify
each of these categories of securities in
Items 3.D.i and 3.E.i, rather than group
them together in the ‘‘Other’’ category.
By identifying these types of
investments separately on Form
Custody, Commission and DEA
examiners will have a better
understanding of a broker-dealer’s
business activities and a more refined
understanding of the types of securities
held by the broker-dealer. This
information, in turn, could facilitate
more focused examinations by
Commission and DEA examiners.
Accordingly, Items 3.D.i and 3.E.i of
Form Custody, as adopted, will contain
six additional rows to account for both
domestic and foreign alternative
investments (referred to on the form as
‘‘private funds’’), mutual funds, and
exchange traded funds. The
Commission is referring to the term
‘‘private funds’’ on the form, rather than
the term ‘‘alternative investments,’’ for
purposes of clarity; while both terms are
often used interchangeably in practice,
the term ‘‘private fund’’ is a regulatory
term defined in other contexts of the
securities laws (e.g., on Form ADV),
whereas the term ‘‘alternative
investments’’ is not. For purposes of
Form Custody, the term ‘‘private fund’’
is given the same meaning as is used by
the Commission on Form ADV—that is,
an investment company as defined in
section 3 of the Investment Company
Act of 1940 but for section 3(c)(1) or
3(c)(7) of that Act. Items 3.D.i and 3.E.i
of Form Custody and the related
Instructions to those Items, as adopted,
reflect these changes.
The charts in Items 3.D.i and 3.E.i, as
proposed, would have each had eight
columns. The first column contained
boxes for each category of security
specified in the Item (and identified in
the second column), as discussed
above.583 The broker-dealer would have
been required to check the box in each
chart for every applicable category of
security it holds for the accounts of
customers and non-customers,
respectively. The second column would
have identified the category of security.
The third through eighth columns
represented ranges of dollar values: (1)
Up to $50 million; (2) greater than $50
million up to $100 million; (3) greater
than $100 million up to $500 million;
(4) greater than $500 million up to $1
billion; (5) greater than $1 billion up to
$5 billion; and (6) greater than $5
billion. In each chart, the broker-dealer
would have been required to check the
box in the column reflecting the
approximate dollar value for every
category of security that the brokerdealer carried for the accounts of
customers and non-customers,
respectively.584
The Commission proposed identifying
dollar ranges for the values of the
securities, as opposed to actual values,
to ease compliance burdens.585 The
intent was to elicit information about
the relative dollar value of securities the
broker-dealer held for customers and
non-customers in each category of
security. Values would be reported as of
the date specified in the broker-dealer’s
accompanying quarterly FOCUS Report.
One commenter noted that the charts
set forth in Items 3.D.i and 3.E.i of
proposed Form Custody did not include
boxes to check to reflect the
approximate dollar values for the
categories of securities the broker-dealer
carried for the accounts of customers
and non-customers.586 This commenter
requested guidance on whether brokerdealers would be required to populate
the chart with checkmarks or more
precise estimates of market value.587
The Commission intended to include
boxes to check to reflect approximate
dollar values in the charts set forth in
Items 3.D.i and 3.E.i of proposed Form
Custody, and the form, as adopted,
includes these boxes.
b. Items 3.D.ii and 3.E.ii
Items 3.D.ii and 3.E.ii of proposed
Form Custody would have elicited
information concerning whether the
broker-dealer had recorded all the
securities it carried for the accounts of
customers and non-customers,
respectively, on its stock record by
requiring the broker-dealer to check the
appropriate ‘‘Yes’’ or ‘‘No’’ box.588 If the
broker-dealer checked ‘‘No,’’ it would
have been required to explain in the
space provided why it had not recorded
such securities on its stock record and
indicate the type of securities and
approximate U.S. dollar market value of
such unrecorded securities.589 The
Commission did not receive any
comments on Items 3.D.ii and 3.E.ii of
584 Id.
585 Id.
586 See
SIFMA Letter.
proposed Form Custody and is adopting
these Items as proposed.
The Commission anticipates that a
broker-dealer ordinarily would answer
‘‘Yes’’ in response to Items 3.D.ii and
3.E.ii because the stock record—which a
broker-dealer is required to create
pursuant to Rule 17a–3 590—is a record
of custody of securities. A long position
in the stock record indicates ownership
of the security or a right to the
possession of the security. Thus, the
‘‘long side’’ of the stock record indicates
the person to whom the broker-dealer
owes the securities. Common examples
of ‘‘long side’’ positions are securities
received from customers (e.g., fully paid
or excess margin securities), securities
owned by the firm (i.e., securities held
in the broker-dealer’s inventory for its
own account), securities borrowed, and
fails-to-deliver (i.e., securities sold to or
through another broker-dealer but not
delivered).
A short position in the stock record
indicates either the location of the
securities or the responsibility of other
parties to deliver the securities to the
broker-dealer. Every security owned or
held by the broker-dealer must be
accounted for by its location. Since
securities are fungible, the short side of
the stock record does not in fact
designate where particular securities are
located. Rather, it indicates the total
amount of securities, on a security-bysecurity basis, held at each location,
which could include, for example,
securities depositories. Common shortside stock record locations also include
banks (e.g., when a broker-dealer
pledges securities to a bank as collateral
for a loan), stock loan counterparties
(e.g., when a broker-dealer lends
securities to another firm as part of a
securities lending transaction), and
counterparties failing to deliver
securities to the broker-dealer (e.g.,
when the broker-dealer has purchased
securities that have not yet been
received from the counterparty).
The Commission’s goals in asking this
question were twofold. First, the
question would elicit the disclosure of
the unusual circumstance in which a
broker-dealer carries securities for the
account of a customer or non-customer
but does not reflect them on its stock
record.591 The Commission and other
securities regulators could use this
information to assess whether the
broker-dealer is properly accounting for
securities. Second, this question could
prompt a broker-dealer to identify, and
self-correct, circumstances in which it
587 Id.
582 See
583 See
SIFMA Letter.
Broker-Dealer Reports, 76 FR at 37587.
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588 See
Broker-Dealer Reports, 76 FR at 37587.
589 Id.
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590 See
591 See
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17 CFR 240.17a–3(a)(5).
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did not include securities on its stock
record as required by Rule 17a-3.592
c. Items 3.D.iii and 3.E.iii
Items 3.D.iii and 3.E.iii of proposed
Form Custody would have elicited
information as to how the broker-dealer
treated free credit balances in securities
accounts of customers and noncustomers, respectively.593 The
information would have been elicited
through a chart the broker-dealer would
be required to complete. The chart in
Item 3.D.iii of proposed Form Custody
had five rows with each row
representing a different process for
treating free credit balances. The chart
would have disclosed whether free
credit balances were: (1) Included in a
computation under Rule 15c3–3(e); (2)
held in a bank account under Rule
15c3–3(k)(2)(i); (3) swept to a U.S. bank;
(4) swept to a U.S. money market fund;
and/or (5) ‘‘other,’’ with a space to
describe such other treatment. The
options were not intended to be
mutually exclusive in that a brokerdealer may treat free credit balances in
several different ways (e.g., a brokerdealer may be instructed by certain
customers to sweep their free credit
balances to a bank, and by other
customers to sweep their free credit
balances to a U.S. money market fund).
The Commission did not receive any
comments on Items 3.D.iii and 3.E.iii of
proposed Form Custody and is adopting
these Items as proposed.
A broker-dealer will be required to
check the box in the first column of the
chart for every process that applies to
the broker-dealer’s treatment of free
credit balances in customer and noncustomer accounts, respectively. The
first process identified on each chart is
that the broker-dealer treats customer
and non-customer free credit balances
in accordance with the customer reserve
computation required under paragraph
(e) of Rule 15c3–3. Paragraph (e) of Rule
15c3–3 requires a broker-dealer to
maintain a special reserve bank account
for the exclusive benefit of its customers
and maintain deposits in that account
(to the extent a deposit is required) in
amounts computed in accordance with
Exhibit A to Rule 15c3–3.594 Rule 15c3–
3 requires that a broker-dealer comply
with these reserve account provisions
only with respect to customer-related
credit balances. The Commission has,
however, proposed amendments to Rule
15c3–3 that would require a brokerdealer to maintain a reserve account and
perform a reserve computation for non592 Id.
593 Id.
594 See
Rule 15c3–3(e) and Rule 15c3–3a.
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customer accountholders that are
domestic and foreign broker-dealers.595
The second process identified on the
chart is that the broker-dealer handles
free credit balances by placing funds in
a ‘‘bank account under Rule 15c3–
3(k)(2)(i).’’ Paragraph (k)(2)(i) of Rule
15c3–3 prescribes a process by which a
broker-dealer can qualify for an
exemption from the requirements of
Rule 15c3–3. Specifically, the
exemption applies to a broker-dealer
that does not carry margin accounts,
promptly transmits all customer funds
and delivers all securities received in
connection with its activities, does not
otherwise hold funds or securities for,
or owe money or securities to,
customers and effectuates all financial
transactions between the broker-dealer
and its customers through one or more
bank accounts that are each designated
as a ‘‘Special Account for the Exclusive
Benefit of Customers of (the name of
broker or dealer).’’ 596
The third process identified in the
chart—‘‘swept to a U.S. bank’’—is
included because some broker-dealers
engage in ‘‘bank sweep programs.’’
Rather than hold customer funds in
securities accounts, some broker-dealers
require or offer the option to transfer
free credit balances in securities
accounts to a specific money market
fund or interest bearing bank account
(‘‘Sweep Programs’’). The customer
earns dividends on the money market
fund or interest on the bank account
until such time as the customer chooses
to liquidate the position in order to use
the cash, for example, to purchase
securities.597 Customers must make a
request to the broker-dealer for the
return of funds swept from their
securities accounts to the bank.
The fourth option identified in the
chart is that the broker-dealer sweeps
free credit balances into a money market
fund as part of a Sweep Program. In
most cases when a broker-dealer sweeps
free credit balances into a money market
fund, the broker-dealer purchases shares
in the money market fund, which are
595 See Amendments to Financial Responsibility
Rules for Broker-Dealers, Exchange Act Release No.
55431 (Mar. 9, 2007), 72 FR 12862 (Mar. 19, 2007);
Amendments to Financial Responsibility Rules for
Broker-Dealers (Reopening of Comment Period),
Exchange Act Release No. 34–66910 (May 3, 2012),
77 FR 27150 (May 9, 2012). See also letter from
Michael A. Macchiaroli, Associate Director,
Division of Market Regulation, Commission, to
Raymond J. Hennessy, Vice President, New York
Stock Exchange (‘‘NYSE’’), and Thomas Cassella,
Vice President, NASD Regulation, Inc. (Nov. 10,
1998).
596 See 17 CFR240.15c3–3(k)(2)(i).
597 See Amendments to Financial Responsibility
Rules for Broker-Dealers, Exchange Act Release No.
55431 (Mar. 9, 2007), 72 FR 12862 (Mar. 19, 2007)
at 12866.
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51953
registered in the name of the brokerdealer. The money market fund
understands that these shares are not
proprietary positions of the brokerdealer, and any interest earned on the
shares from the money market fund are
payable to the customers.
Finally, the fifth option in the chart
covers any other process that is not
described in the other options.
4. Item 4—Carrying for Other BrokerDealers
Item 4 of proposed Form Custody
would have required a broker-dealer to
disclose whether it acted as a carrying
broker-dealer for other brokerdealers.598 There were two sets of
questions in Item 4—Item 4.A.i, ii, and
iii and Item 4.B.i, ii, and iii. The first set
of questions would have elicited
information from a broker-dealer as to
whether it carried transactions for other
broker-dealers on a fully disclosed
basis.599 The second set of questions
would have elicited information from a
broker-dealer as to whether it carried
transactions for other broker-dealers on
an omnibus basis.600 The Commission
did not receive any comments to Item 4
of proposed Form Custody and is
adopting this Item as proposed.
Items 4.A.i and 4.B.i require a brokerdealer to indicate by checking the
appropriate ‘‘Yes’’ or ‘‘No’’ box whether
it carries customer accounts for another
broker-dealer on a fully disclosed basis
and on an omnibus basis, respectively.
Items 4.A.ii and 4.B.ii require a brokerdealer, if applicable, to indicate the
number of broker-dealers with which it
has an arrangement to carry accounts on
a fully disclosed basis and on an
omnibus basis, respectively. Items
4.A.iii and 4.B.iii require a brokerdealer, if applicable, to identify any
affiliated broker-dealers that introduce
accounts to the broker-dealer on a fully
disclosed basis and on an omnibus
basis, respectively.
As the Commission has noted, related
person custody arrangements can
present higher risks to ‘‘advisory
clients’’ than maintaining assets with an
independent custodian.601 Consistent
with the definition of the term in other
contexts applicable to broker-dealers,
including Form BD,602 the General
598 See
Broker-Dealer Reports, 76 FR at 37589.
599 Id.
600 Id.
601 See Custody of Funds or Securities of Clients
by Investment Advisers, 75 FR at 1462.
602 Form BD is the uniform application for brokerdealer registration with the Commission. Form BD
states that a person is presumed to control a
company if, among other things, that person has
directly or indirectly the right to vote 25% or more
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Instructions for Form Custody define
the term ‘‘affiliate’’ as any person who
directly or indirectly controls the
broker-dealer or any person who is
directly or indirectly controlled by or
under common control with the brokerdealer. The definition also specifies that
ownership of 25% or more of the
common stock of the broker-dealer
introducing accounts to the brokerdealer submitting the Form Custody is
deemed prima facie evidence of control;
this provision also is consistent with the
definition used in Form BD.603
Item 4 in Form Custody elicits
information about broker-dealers’
custodial responsibilities with respect to
accounts held for the benefit of other
broker-dealers, and requires brokerdealers to identify such broker-dealers
that are affiliates of the broker-dealer.604
The Commission believes that this
information will provide the
Commission with an enhanced
understanding of, and useful and
readily available information relating to,
the scope of broker-dealer introducing/
carrying relationships and activities,
and the custodial practices of brokerdealers involved in such relationships.
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5. Item 5—Trade Confirmations
Item 5 of Form Custody, as proposed,
would have required broker-dealers to
disclose whether they send transaction
confirmations to customers and other
accountholders by checking the
appropriate ‘‘Yes’’ or ‘‘No’’ box.605
Confirmations are important safeguards
that enable customers to monitor
transactions that occur in their
securities accounts. Timely
of a class of a voting security or has the power to
sell or direct the sale of 25% or more of a class of
voting securities, or, in the case of a partnership,
the right to receive upon dissolution, or has
contributed, 25% or more of the firm’s capital.
603 This definition of the term affiliate is the same
as the definition in Form BD, including the
specification that ownership of 25% or more of the
common stock is deemed prima facie evidence of
control.
604 Form Custody does not require a broker-dealer
to identify unaffiliated broker-dealers for which it
carries accounts, though, as discussed above, it
would need to indicate that it carries accounts for
such broker-dealers. The Commission believes that
this approach provides the Commission and DEA
examiners with access to useful information
involving a broker-dealer’s custody practices while
alleviating potential time and cost burdens
associated with completing Form Custody given
that some broker-dealers carry accounts for
hundreds of unaffiliated broker-dealers. The
Commission notes that information about these
broker-dealers would be part of the books and
records of the carrying broker-dealer. Therefore, an
affirmative answer to Item 4 could prompt the
Commission and DEA examiners to request
information about the identities of the unaffiliated
broker-dealers. See Broker-Dealer Reports, 76 FR at
37589 n.143.
605 See Broker-Dealer Reports, 76 FR at 37589–
37590.
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confirmations alert customers of
unauthorized transactions and provide
customers with an opportunity to object
to the transactions. The Commission
received one comment on Item 5 of
proposed Form Custody. As discussed
below, the Commission is modifying the
instructions to Item 5 in response to this
comment and is otherwise adopting
Item 5 as proposed.
Exchange Act Rule 10b–10 specifies
the information a broker-dealer must
disclose to customers on a trade
confirmation at or before completion of
a securities transaction.606 Generally,
Rule 10b–10 requires a confirmation to
include, among other things: (1) The
date and time of the transaction and the
identity, price, and number of shares or
units (or principal amount) of such
security purchased or sold by such
customer; (2) the broker-dealer’s
capacity (agent or principal) and its
compensation; (3) the source and
amount of any third party remuneration
it has received or will receive; and (4)
other information, both general (e.g.,
that the broker-dealer is not a SIPC
member, if such is the case) and
transaction-specific (e.g., certain yield
information in most transactions
involving debt securities).607
The information contained on a trade
confirmation should reconcile with
customer statements and the brokerdealer’s journal entries.608 In this
regard, there is a link between trade
confirmations sent by a broker-dealer
and the broker-dealer’s records
pertaining to custody of customer
assets.609 How a broker-dealer answers
Item 5 could assist examiners in
focusing their inspections. For example,
if the form indicates that a third party
is responsible for sending trade
606 17
CFR 240.10b–10.
607 Id.
608 See 17 CFR 240.17a–3(a)(1), which requires
the broker-dealer to make ‘‘[b]lotters (or other
records of original entry) containing an itemized
daily record of all purchases and sales of securities,
all receipts and deliveries of securities (including
certificate numbers), all receipts and disbursements
of cash and all other debits and credits. Such
records shall show the account for which each such
transaction was effected, the name and amount of
securities, the unit and aggregate purchase or sale
price (if any), the trade date, and the name or other
designation of the person from whom purchased or
received or to whom sold or delivered.’’
609 Although broker-dealers may allocate the
function of sending confirmations to other brokerdealers or to service providers, the allocating
broker-dealer retains the responsibility for sending
confirmations. See New York Stock Exchange, Inc.;
Order Approving Proposed Rule Change, Exchange
Act Release No. 18497 (Feb. 19, 1982), 47 FR 8284
(Feb. 25, 1982) at n.2 (providing ‘‘no contractual
arrangement for the allocation of functions between
an introducing and carrying organization can
operate to relieve either organization from their
respective responsibilities under the federal
securities laws and applicable SRO rules’’).
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confirmations, the examiners can
confirm with that third party that it is
in fact sending confirmations.
With respect to Item 5.A, one
commenter requested clarification as to
whether a broker-dealer should indicate
that it sends trade confirmations
directly to customers (by checking
‘‘yes’’) where it employs a vendor to do
so.610 The Commission has considered
this comment and determined that a
broker-dealer should affirmatively
respond to Item 5 of Form Custody, as
adopted, by checking the ‘‘yes’’ box on
the form if it employs a vendor to send
trade confirmations to customers on its
behalf because, in such an arrangement,
the broker-dealer is ultimately
responsible for complying with its trade
confirmation obligations, not the
vendor. The Commission has modified
the instructions to Item 5 to reflect this
clarification.
6. Item 6—Account Statements
Item 6 of proposed Form Custody
would have required broker-dealers to
disclose whether they send account
statements directly to customers and
other accountholders by checking the
appropriate ‘‘Yes’’ or ‘‘No’’ box.611 The
Commission received one comment on
Item 6 of proposed Form Custody.612 As
is discussed below, the Commission is
modifying the instructions to Item 6 in
response to this comment and is
otherwise adopting Item 6 as proposed.
Account statements generally are sent
to customers and other accountholders
on a monthly or quarterly basis and
typically set forth the assets held in the
investor’s securities account as of a
specific date and the transactions that
occurred in the account during the
relevant period. SROs impose
requirements on broker-dealers with
respect to the statements they must send
to their customers.613 For example,
FINRA generally requires any member
that conducts a general securities
business and also carries customer
accounts or holds customer funds or
securities, at least once each calendar
quarter, to send an account statement to
each customer whose account had a
security position, money balance, or
account activity since the last statement
was sent.614 The account statement
610 See
611 See
SIFMA Letter.
Broker-Dealer Reports, 76 FR at 37590–
37591.
612 See SIFMA Letter.
613 See, e.g., NASD Rule 2340.
614 See NASD Rule 2340. NASD Rule 2340
defines a general securities member as any member
that conducts a general securities business and is
required to calculate its net capital pursuant to Rule
15c3–1. NASD Rule 2340(d)(2). Additionally, NASD
Rule 2340 defines account activity broadly so that
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must contain a description of any
securities positions, money balances, or
account activity in the account. In
addition, the account statement must
include a statement that advises the
customer to report promptly any
inaccuracy or discrepancy in that
person’s account to the brokerage
firm.615 The statement also is required
to advise the customer that any oral
communications made to the brokerdealer regarding inaccuracies or
discrepancies should be re-confirmed in
writing to further protect the customer’s
rights, including rights under SIPA.616
Like trade confirmations, account
statements are important safeguards that
allow investors to monitor transactions
that occur in their securities accounts. If
the account statements are sent by a
broker-dealer other than the brokerdealer completing Form Custody, this
fact will need to be disclosed on the
Form in Item 6.B. Item 6.C asks whether
the broker-dealer sends account
statements to anyone other than the
beneficial owner of the account.617 In
response to a request for clarification
raised by one commenter to proposed
Item 6.C,618 a broker-dealer also would
check ‘‘Yes’’ to Item 6.C if the brokerdealer sends account statements to the
beneficial owner of an account and
duplicate account statements to persons
other than the beneficial owner of the
account. The Commission has modified
the instructions to Item 6 to reflect this
clarification.
The Commission is requiring brokerdealers to answer the questions in Item
6 to enhance its understanding of a
broker-dealer’s relationship with
customers, particularly in the context of
the broker-dealer’s custodial
responsibilities. Broker-dealers do not
currently disclose to the Commission
whether they send account statements
it includes, but is not limited to, purchases, sales,
interest credits or debits, charges or credits,
dividend payments, transfer activity, securities
receipts or deliveries and/or journal entries relating
to securities or funds in the possession or control
of the member. NASD Rule 2340(d)(1). See also
Order Approving Proposed Rule Change Relating to
Rule 2340 Concerning Customer Account
Statements, Exchange Act Release No. 54411 (Sept.
7, 2006), 71 FR 54105 (Sept. 13, 2006) (order
granting approval of a proposed rule change relating
to Rule 2340 concerning customer account
statements).
615 If the customer’s account is serviced by both
an introducing broker-dealer and a clearing brokerdealer, the statement must inform customers that
such reports must be made to both firms. See NASD
Rule 2340(a).
616 Id.
617 Generally, the beneficial owner of an account
represents the person entitled to the economic
benefits of ownership. With respect to securities,
the term beneficial owner is defined in Rule 13d–
3 under the Exchange Act. See 17 CFR 240.13d–3.
618 See SIFMA Letter.
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directly to customers. Collecting this
information on Form Custody will
provide examiners with additional
background information that could be
used to refine the focus of their
inspections. Further, the Commission
anticipates that examiners would make
further inquiries to the extent the Form
reveals answers that are inconsistent
with industry practice.
A review of Item 6 also may facilitate
an examiner’s preparation for an
inspection. For example, if a brokerdealer indicates on Form Custody that it
holds customer accounts and sends
account statements to customers, the
examiner could prepare a more targeted
document request to the broker-dealer.
In this regard, an examiner could
request customer account statements
from the broker-dealer, as well as
statements from the custodian(s) of the
broker-dealer’s customer securities and
cash.619 Examiners could then review
and reconcile these documents to verify
whether customer securities and cash
are held at the custodian(s) identified by
the broker-dealer.
7. Item 7—Electronic Access to Account
Information
Item 7 of proposed Form Custody
would have required broker-dealers to
indicate whether they provided
customers and other accountholders
with electronic access to information
about the securities and cash positions
in their accounts by checking the
appropriate ‘‘Yes’’ or ‘‘No’’ box.620
Electronic access to account information
can provide investors with an efficient
means of monitoring transactions that
occur in their securities accounts. This
inquiry would inform the Commission
as to how readily customers are able to
access and review their account
information. The Commission did not
receive any comments to Item 7 of
proposed Form Custody and is adopting
this Item as proposed.
The Commission believes that
electronic access to account information
is beneficial to customers, who can
more easily monitor the performance of
their accounts and perhaps more
quickly identify any discrepancies or
inaccuracies. The Commission is
including this Item in Form Custody
because it will help to inform examiners
as to how readily customers can access
and review account information.
619 As is discussed above in section IV.C.3. of this
release, the fact that a broker-dealer uses a
custodian to hold customer securities and cash, and
the type of custodian, will be disclosed in response
to Items 3.C and 3.D of Form Custody.
620 See Broker-Dealer Reports, 76 FR at 37591.
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51955
8. Item 8—Broker-Dealers Registered as
Investment Advisers
Item 8 of Form Custody, as proposed,
would have elicited information, if
applicable, as to whether and how the
broker-dealer operated as an investment
adviser.621 Proposed Item 8 was
comprised of three subparts, as
described below.
The first question of Item 8—Item
8.A—would have required the brokerdealer to indicate whether it was
registered as an investment adviser with
the Commission under the Advisers Act
or with one or more states pursuant to
the laws of a state.622 If the brokerdealer indicated that it was registered
with the Commission under the
Advisers Act or pursuant to state law (or
both), then it would have been required
to respond to the remaining questions
under Item 8.623
The next question of Item 8 of
proposed Form Custody—Item 8.B—
would have required the broker-dealer
to disclose the number of its investment
adviser clients.624 This would provide
the Commission with information about
the scale of the broker-dealer’s
investment adviser activities.
The third question of Item 8 of
proposed Form Custody—Item 8.C—
would have required the broker-dealer
to complete a chart, consisting of six
columns, in which the broker-dealer
would have provided information about
the custodians where the assets of the
investment adviser clients were held.625
621 Id.
at 37591–37592.
Section 203A of the Advisers Act prohibits
certain investment advisers from registering with
the Commission based on the advisers’ assets under
management, among other factors. See 17 CFR
275.203A.
623 See Broker-Dealer Reports, 76 FR at 37591.
624 Id.
625 Id. Under Rule 206(4)–2, it is a ‘‘fraudulent,
deceptive, or manipulative act, practice or course of
business’’ for an investment adviser registered or
required to be registered under section 203 of the
Advisers Act (15 U.S.C. 80b–3) to have custody of
client funds or securities unless, among other
things, a qualified custodian maintains those funds
or securities. See 17 CFR 275.206(4)–2(a)(1). A
qualified custodian is: (1) A bank as defined in
section 202(a)(2) of the Advisers Act or savings
association as defined in section 3(b)(1) of the
Federal Deposit Insurance Act (12 U.S.C.
1813(b)(1)) that has deposits insured by the Federal
Deposit Insurance Corporation under the Federal
Deposit Insurance Act (2 U.S.C. 1811); (2) a brokerdealer registered under section 15(b)(1) of the
Exchange Act holding the client assets in customer
accounts; (3) an FCM registered under section 4f(a)
of the Commodity Exchange Act (7 U.S.C. 6f(a)),
holding the client assets in customer accounts, but
only with respect to clients’ funds and security
futures, or other securities incidental to transactions
in contracts for the purchase or sale of a commodity
for future delivery and options thereon; and (4) a
foreign financial institution that customarily holds
financial assets for its customers, provided that the
foreign financial institution keeps the advisory
622 Id.
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In the first column, the broker-dealer
would have been required to disclose
the name of the custodian, and in the
second column, the broker-dealer would
have been required to identify the
custodian by either SEC file number or
CRD number, as applicable.626
The third and fourth columns of the
chart would have elicited information
about the scope of the broker-dealer/
investment adviser’s authority over the
accounts held at the custodian by
requiring the broker-dealer/investment
adviser to check the appropriate ‘‘Yes’’
or ‘‘No’’ box.627 Specifically, in the third
column, the broker-dealer/investment
adviser would have been required to
indicate whether it had the authority to
effect transactions in the advisory client
accounts at the custodian. In the fourth
column, the broker-dealer/investment
adviser would have been required to
indicate whether it had the authority to
withdraw funds and securities from
those accounts.
In the fifth column, the broker-dealer/
investment adviser would have been
required to indicate whether the
custodian sends account statements
directly to the broker-dealer’s
investment adviser clients.628 The
Commission recently adopted
amendments to Rule 206(4)–2 to require
that investment advisers have a
reasonable basis, after due inquiry, for
believing that qualified custodians of
advisory client assets send account
statements to the investment advisers’
clients. As stated in the release adopting
that requirement, the Commission
believes that the direct delivery of
account statements by qualified
custodians provides greater assurance of
the integrity of account statements
received by clients.629
In the sixth column, the brokerdealer/investment adviser would have
been required to indicate whether
investment adviser client assets were
recorded on the broker-dealer’s stock
record.630 If the broker-dealer was acting
as custodian for such assets, the
Commission anticipates that those
clients’ assets in customer accounts segregated from
its proprietary assets. See 17 CFR 275.206(4)–
2(d)(6). A qualified custodian must maintain client
funds and securities: (1) In a separate account for
each client under that client’s name; or (2) in
accounts that contain only the clients’ funds and
securities, under the investment adviser’s name as
agent or trustee for the clients. See 17 CFR
275.206(4)–2(a)(1).
626 See Broker-Dealer Reports, 76 FR at 37591.
627 Id.
628 Id.
629 See, e.g., Custody of Funds or Securities of
Clients by Investment Advisers, 75 FR at 1465.
630 See Broker-Dealer Reports, 76 FR at 37591.
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assets would be recorded on the brokerdealer’s stock record.631
The Commission received one
comment in response to Item 8 of Form
Custody, as proposed.632 This
commenter stated that the information
sought in Item 8 was largely redundant
with information collected from
investment advisers on Form ADV. The
Commission is aware that some overlap
exists between the information collected
from investment advisers on Form ADV
and the information that would be
collected from broker-dealers duallyregistered as investment advisers in
Item 8 of proposed Form Custody.
However, these two forms also contain
a significant amount of non-overlapping
material, reflecting their different
purposes and uses. Form Custody is
intended to be a single source of readilyavailable information to assist
Commission and DEA examiners in
preparing for and performing focused
custody exams, and it is particularly
important that such information be
readily available in the case of duallyregistered firms. Accordingly, the
Commission is adopting Item 8 of Form
Custody substantially as proposed.633
9. Item 9—Broker-Dealers Affiliated
With Investment Advisers
Item 9 of Form Custody consists of
two subparts. Item 9.A, as proposed,
would have elicited information
concerning whether the broker-dealer
was an affiliate of an investment
adviser.634 Item 9.B.i, as proposed,
would have elicited information from a
broker-dealer that checks ‘‘Yes’’ in
response to Item 9.A to identify whether
it has custody of client assets of the
adviser, and, if Item 9.B.i is checked
‘‘Yes,’’ to indicate the approximate U.S.
dollar market value of the adviser client
assets of which the broker-dealer has
631 If the broker-dealer acts as custodian for an
investment adviser client’s securities, and does not
record those securities on its stock record, the
broker-dealer would need to explain why those
securities were not recorded on its stock record in
response to the question in Item 3.D.ii of Form
Custody.
632 See Angel Letter.
633 Column 2 of Item 8.C of Form Custody, as
proposed, would have required a broker-dealer/
investment adviser to identify the SEC File No. or
CRD No. of each custodian where assets of
investment adviser clients were held. However, not
all custodians of investment adviser client assets
have an SEC File No. or CRD No. Accordingly, the
instructions applicable to Column 2 of Item 8.C, as
adopted, have been modified to provide that a
broker-dealer needs to identify custodians in the
column by SEC File No. or CRD No., ‘‘if
applicable.’’ Thus, a broker-dealer can leave
Column 2 of Item 8.C blank if assets of its
investment adviser clients are held at a custodian
that does not have an SEC File No. or CRD No.
634 See Broker-Dealer Reports, 76 FR at 37592.
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custody.635 The Commission did not
receive any comments to Item 9 of
proposed Form Custody and is adopting
this Item as proposed. The additional
information obtained from a brokerdealer in response to Item 9 will provide
SEC and DEA examiners with a better
understanding of a broker-dealer’s
custody profile and, in particular,
custodial relationships with investment
adviser affiliates.
For purposes of Item 9, an affiliate is
any person who directly or indirectly
controls the broker-dealer or any person
who is directly or indirectly controlled
by or under common control with the
broker-dealer. Ownership of 25% or
more of the common stock of the
investment adviser is deemed prima
facie evidence of control.636
V. Effective Dates
As discussed below, the Commission
has established December 31, 2013 as
the effective date for the requirement to
file Form Custody and the requirement
to file annual reports with SIPC. The
Commission is delaying the effective
date for the requirements relating to
broker-dealer annual reports to June 1,
2014. These delayed effective dates are
intended to provide time for brokerdealers, broker-dealer independent
public accountants, and broker-dealer
DEAs to prepare for the changes that
will result from these new requirements.
The amendments relating to brokerdealer annual reports and the other
amendments to Rule 17a–5 (including
the technical amendments) affect
numerous paragraphs in that rule and
two paragraphs in Rule 17a–11. Given
the complexity and practical difficulty
of having certain provisions become
effective before others, the amendments
to Rule 17a–5 and the amendments to
Rule 17a–11 will become effective on
June 1, 2014, regardless of whether they
relate to the annual report requirements,
except that there will be different
effective dates for the amendments to
paragraph (a) of Rule 17a–5 (which
includes the filing requirement for Form
Custody), Form Custody, the deletion of
paragraph (e)(5) of Rule 17a–5 (which
sets forth the requirement to file Form
BD–Y2K), and the requirement to file
annual reports with SIPC. The effective
dates for the remaining paragraphs of
Rule 17a–5 and Rule 17a–11 are
discussed further below.
635 Id.
636 See supra note 603 and corresponding text
which specifies the same ownership percentage on
Form BD.
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A. Amendments Effective 60 Days After
Publication in the Federal Register
Before today’s amendments,
paragraph (e)(5) of Rule 17a–5 required
a broker-dealer to file Form BD–Y2K,
which elicits information with respect
to a broker-dealer’s readiness for the
year 2000 and any potential problems
that could arise with the advent of the
new millennium. The Commission is
deleting this paragraph from Rule 17a–
5 as the requirement is no longer
applicable. The amendment deleting
paragraph (e)(5) of Rule 17a–5 will be
effective 60 days after this release is
published in the Federal Register.
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B. Amendments Effective on December
31, 2013
The amendments to paragraph (a) of
Rule 17a–5 and the rule establishing
Form Custody (17 CFR 249.639) are
effective on December 31, 2013. The
amendments to paragraph (a) include
the requirement for a broker-dealer to
file Form Custody with its DEA.637
Consequently, broker-dealers subject to
this filing requirement must begin filing
Form Custody with their DEAs 17
business days after the calendar quarter
or fiscal year, as applicable, ended
December 31, 2013.
Two commenters requested that the
Commission provide broker-dealers
with sufficient time to develop, test, and
implement the systems that they will
use to comply with the Form Custody
filing requirements.638 The Commission
understands that broker-dealers will
need to allocate personnel and systems
resources to comply with the Form
Custody filing requirements,
particularly for a broker-dealer’s initial
filing. DEAs also will need to be
prepared to receive the forms that are
filed by broker-dealers. Establishing
December 31, 2013 as the effective date
of the Form Custody requirements is
designed to accommodate the efforts
that need to be undertaken by both
broker-dealers and DEAs in connection
with the filing and receipt of Form
Custody.
Additionally, the amendment to
paragraph (d)(6) of Rule 17a–5 is
effective on December 31, 2013. Brokerdealer annual reports must be filed with
SIPC for fiscal years ending on or after
December 31, 2013.
C. Amendments Effective on June 1,
2014
The amendments to paragraphs (b),
(c), (d)(1), (d)(2), (d)(3), (d)(4), (d)(5),
(e)(1), (e)(2), (e)(3), (e)(4), (f), (g), (h), (i),
(k), (l), (m) and (n) and the deletion of
637 See
638 See
paragraph (a)(5) of Rule 17a–5.
E&Y Letter; SIFMA Letter.
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paragraph (j) of Rule 17a–5 and the
amendments to Rule 17a–11 are
effective on June 1, 2014. Consequently,
all of the amendments to Rule 17a–5 not
discussed above in sections V.A. and
V.B. of this release and the amendments
to Rule 17a–11 are effective on that date.
This includes the amendments relating
to the annual report requirements, with
the exception of the requirement to file
annual reports with SIPC, which is
effective on December 31, 2013. In 2014,
therefore, the annual report
requirements will apply to all brokerdealers subject to these requirements
that have a fiscal year ending on or after
June 1, 2014.
The Commission proposed that the
amendments would apply for fiscal
years ending on or after December 15,
2011, with a first-year transition period
for carrying broker-dealers required to
file compliance reports with fiscal years
ending on or after December 15, 2011
but before September 15, 2012.639 The
Commission received 14 comments
concerning the compliance date of the
amendments.640 Most commenters
recommended that the Commission
delay the compliance date. One
commenter, however, stated that brokerdealers should start working on
compliance immediately.641 Several
stated that the compliance date of the
amendments should be aligned with the
effective date of the proposed PCAOB
standards for engagements related to
compliance reports and exemption
reports.642 One commenter suggested
that the Commission postpone the
assertion requirements until the rule has
been in effect for one year.643 Another
commenter stated that the rules should
be effective for fiscal years ending on or
before December 15, 2012 ‘‘to allow
sufficient time to complete robust
documentation and testing of the
processes related to the Financial
Responsibility Rules and the Financial
Statements.’’ 644 Similarly, another
commenter stated that the effective date
should be deferred to fiscal years ending
on or before December 15, 2012 ‘‘to give
broker-dealers and their auditors time to
639 See Broker-Dealer Reports, 76 FR at 37581.
During the transition period, the statement in the
compliance report as to whether internal control
was effective would have been a point-in-time
statement as of the date of the report, rather than
covering the entire fiscal year.
640 See, e.g., ABA Letter; AICPA Letter; CAQ
Letter; Citrin Letter; Deloitte Letter; E&Y Letter;
Grant Thornton Letter; KPMG Letter; McGladrey
Letter; PWC Letter; SIFMA Letter; Shatto Letter; CAI
Letter; Van Kampen/Invesco Letter.
641 See Shatto Letter.
642 See, e.g., CAQ Letter; Deloitte Letter; Grant
Thornton Letter; KPMG Letter; McGladrey Letter.
643 See ABA Letter.
644 See Van Kampen/Invesco Letter.
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51957
adequately address the final rules,’’ and
that the effective date should be aligned
with the effective date of PCAOB
standards.645 Another commenter stated
that the rule amendments should apply
only to annual reports filed on or after
December 15, 2012, and that
implementation of the proposal must be
postponed until after the PCAOB
establishes auditing and attestation
standards and broker-dealers have had
ample time to plan and budget for the
new standards.646 Finally, a commenter
stated that broker-dealers should be
required to file the first compliance
report or exemption report no earlier
than one quarter after the adoption of
the final rule amendments and to report
identified instances of material noncompliance or material weaknesses in
annual reports filed no earlier than five
quarters after the adoption of the final
rule amendments, with a transition
period as proposed of no less than five
quarters after the adoption of the final
rule amendments.647 This commenter
also suggested that the Commission
require the filing of the first Form
Custody no earlier than three quarters
after the effective date of the final
rule.648
The amendments, among other things,
establish important new safeguards with
respect to broker-dealer custody of
customer funds and securities.
However, the Commission recognizes
that broker-dealers and other affected
parties may need additional time to
prepare to comply with the new
requirements.
Amendments to provisions regarding
broker-dealer annual reports and the
engagement of an independent public
accountant in paragraphs (d)(1), (d)(2),
(d)(3), (d)(4), (d)(5), (e)(1), (e)(2), (e)(3),
(e)(4), (g), and (i) of Rule 17a–5 and the
deletion of paragraph (j) of Rule 17a–5
generally will apply for broker-dealers
with fiscal years ending on or after June
1, 2014. In particular, broker-dealers
must file compliance reports or
exemption reports, as applicable, and
broker-dealers must file reports of
independent public accountants
covering compliance reports or
exemption reports in accordance with
Rule 17a–5 as amended, for fiscal years
ending on or after June 1, 2014, with no
transition period. Similarly, PCAOB
standards, rather than GAAS, apply to
examinations of financial reports for
fiscal years ending on or after June 1,
2014. For broker-dealers with fiscal
years that end before June 1, 2014,
645 See
E&Y Letter.
CAI Letter.
647 See SIFMA Letter.
648 Id.
646 See
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
applicable reports must be filed in
accordance with the provisions of Rule
17a–5 as they existed before today’s
amendments.
Amendments to the customer
statement provisions of paragraph (c) of
Rule 17a–5 apply for fiscal years ending
on or after June 1, 2014, and in the
interim broker-dealers must comply
with those provisions as they existed
before today’s amendments.
Paragraph (f)(2) of Rule 17a–5 requires
a broker-dealer to file a statement
regarding its independent public
accountant on December 10 of each
year. As a result of today’s amendments,
all broker-dealers that are required by
Rule 17a–5 to engage an independent
public accountant must file a new
statement by December 10, 2013 that
contains the information and
representations required under
paragraph (f)(2) of Rule 17a–5 as
amended. For example, after today’s
amendments, the statement must
include a representation that the
accountant has undertaken the
engagement of the accountant
provisions of paragraph (g) of Rule 17a–
5 as amended. The statement also must
include, if applicable, representations
regarding access to the broker-dealer’s
independent public accountant and the
audit documentation of the independent
public accountant.
The amendments to the notification
provisions in paragraph (h) of Rule 17a–
5 and amendments to Rule 17a–11 are
effective on June 1, 2014. In the interim,
these provisions as they existed before
today’s amendments continue to apply.
Finally, the amendments to
paragraphs (b), (c), (d)(1), (d)(2), (d)(3),
(d)(4), (d)(5), (e)(1), (e)(2), (e)(3), (e)(4),
(f), (g), (h), (i), (k), (l), (m), and (n) of
Rule 17a–5 and the amendments to Rule
17a–11 not discussed above, including
technical amendments, are effective on
June 1, 2014.
With respect to the annual report
requirements, the June 1, 2014 effective
date should provide sufficient time for
the PCAOB to finalize, and for the
Commission to consider, proposed
standards applicable to broker-dealer
examinations and reviews and for
broker-dealers and their accountants to
become familiar with, and be prepared
to comply with, those standards. The
Commission has chosen a specific
effective date, instead of aligning that
date with the date of adoption of the
rule amendments or the date that the
Commission approves PCAOB standards
applicable to broker-dealer
examinations and reviews, as suggested
by commenters, to provide certainty
regarding the date by which brokerdealers and their accountants must
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comply with the new requirements.
Certain commenters referenced AICPA
guidance with respect to broker-dealer
audits. However, this guidance will no
longer be applicable for fiscal years
ending on or after June 1, 2014, when
standards of the PCAOB begin to apply.
One commenter suggested that the
effective date for non-carrying and
smaller broker-dealers to comply with
amendments to the annual reporting
requirements should be one year after
the adoption of the amendments.649 The
Commission notes that most smaller
broker-dealers are non-carrying firms
and, therefore, will be required to file
the exemption report and a report of the
independent public accountant based
on a review of the exemption report. As
discussed in sections VI. and VII. of this
release, the hour burdens and costs of
the exemption report requirements will
be substantially less than the hour
burdens and costs of the compliance
report requirements. Consequently, the
Commission does not believe the
effective date should be extended
further for smaller broker-dealers.
As stated above, another commenter
suggested that the Commission
postpone the assertion requirements
until the rule has been in effect for one
year.650 The Commission recognizes
that all broker-dealers subject to these
requirements and their independent
public accountants will need time to
prepare to comply with the
requirements. The effective date the
Commission is establishing should
provide sufficient time for small or noncarrying firms, as well as larger carrying
firms, to prepare for compliance with
the new requirements.
VI. Paperwork Reduction Act
Certain provisions of the final rule
amendments contain ‘‘collection of
information’’ requirements within the
meaning of the Paperwork Reduction
Act of 1995 (‘‘PRA’’).651 The
Commission solicited comment on the
estimated burden associated with the
collection of information requirements
in the proposed amendments.652 The
Commission submitted the proposed
collection of information requirements
to the Office of Management and Budget
(‘‘OMB’’) for review in accordance with
44 U.S.C. 3507 and 5 CFR 1320.11.
The titles and OMB control numbers
for the collections of information are:
(1) Rule 17a–5, Reports to be made by
certain brokers and dealers (OMB
Control Number 3235–0123);
Citrin Letter.
ABA Letter.
651 44 U.S.C. 3501 et seq.
652 See Broker-Dealer Reports, 76 FR at 37594–
37598.
(2) Rule 17a–11, Notification
provisions for brokers and dealers (OMB
Control Number 3235–0085); and
(3) Form Custody (OMB Control
Number 3235–0691).
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
requirement unless it displays a
currently valid OMB control number. As
discussed above, the Commission
received 27 comment letters on the
proposed rulemaking. Some of these
comments relate directly or indirectly to
the PRA. These comments are addressed
below. Finally, some initial burden
estimates have been adjusted, as
discussed below, to reflect updated
information used to make the estimates.
A. Summary of the Collection of
Information Requirements
As discussed in greater detail above in
sections II., III., and IV. of this release,
the Commission is adopting
amendments to Rules 17a–5 and 17a–11
and is adopting new Form Custody for
broker-dealers to file with their DEA.
Under the amendments to Rule 17a–
5, broker-dealers must, among other
things, file with the Commission annual
reports consisting of a financial report
and one of two new reports—either a
compliance report or an exemption
report that are prepared by the brokerdealer, and generally must also file
reports prepared by an independent
public accountant registered with the
PCAOB covering those reports in
accordance with PCAOB standards.653
The financial report must contain the
same types of financial statements that
were required to be filed under Rule
17a–5 prior to these amendments (a
statement of financial condition, a
statement of income, a statement of cash
flows, and certain other financial
statements).654 In addition, the financial
report must contain, as applicable, the
supporting schedules that were required
to be filed under Rule 17a–5 prior to
these amendments (a computation of net
capital under Rule 15c3–1, a
computation of the reserve requirements
under Rule 15c3–3, and information
relating to the possession or control
requirements under Rule 15c3–3).
A broker-dealer that does not claim an
exemption from Rule 15c3–3 through
the most recent fiscal year—generally a
carrying broker-dealer—must file the
compliance report, and a broker-dealer
that claimed an exemption from Rule
15c3–3 throughout the most recent
649 See
650 See
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653 See discussion above in sections II.B.1., II.B.2.,
II.B.3., and II.B.4. of this release.
654 See discussion above in section II.B.2. of this
release.
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fiscal year must file the exemption
report. In the compliance report and
exemption report, a broker-dealer must
make certain statements and provide
certain information relating to the
financial responsibility rules.
In addition to preparing and filing the
financial report and the compliance
report or exemption report, a brokerdealer must engage a PCAOB-registered
independent public accountant to
prepare a report based on an
examination of the broker-dealer’s
financial report in accordance with
PCAOB standards.655 A broker-dealer
that files a compliance report also must
engage the PCAOB-registered
independent public accountant to
prepare a report based on an
examination of certain statements in the
compliance report.656 A broker-dealer
that files an exemption report must
engage the PCAOB-registered
independent public accountant to
prepare a report based on a review of
certain statements in the broker-dealer’s
exemption report. In each case, the
examination or review must be
conducted in accordance with PCAOB
standards. A broker-dealer must file
these reports of the independent public
accountant with the Commission along
with the financial report and the
compliance report or exemption report
prepared by the broker-dealer.
The amendments add a requirement
that the annual reports also be filed with
SIPC if the broker-dealer is a member of
SIPC.657 In addition, broker-dealers
must generally file with SIPC a
supplemental report on the status of the
membership of the broker-dealer in
SIPC.658 The supplemental report must
include a report of the independent
public accountant based on certain
procedures specified in the rule in
accordance with PCAOB standards. In
the future, SIPC may determine the
format of this report by rule, subject to
Commission approval.
Under the amendments, the PCAOBregistered independent public
accountant must immediately notify the
broker-dealer if the accountant
determines during the course of
preparing the accountant’s reports that
the broker-dealer was not in compliance
at any time during the fiscal year with
the financial responsibility rules or if
the accountant determines that any
material weakness existed in the broker655 See discussion above in section II.D.3. of this
release.
656 See paragraphs (f)(1) and (g)(2)(i) of Rule 17a–
5.
657 See discussion above in section II.B.6. of this
release.
658 See discussion above in section II.C.4. of this
release.
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dealer’s Internal Control Over
Compliance during the fiscal year.659
The broker-dealer, in turn, must file a
notification with the Commission and
its DEA under Rule 15c3–1, Rule 15c3–
3, or Rule 17a–11 if the accountant’s
notice concerns an instance of noncompliance that would trigger
notification under those rules. Under
amendments to Rule 17a–11, a brokerdealer also must file a notification with
the Commission and its DEA if the
accountant’s notice concerns (or if the
broker-dealer discovers) a material
weakness in the broker-dealer’s Internal
Control Over Compliance.
The amendments also require a
broker-dealer that clears transactions or
carries customer accounts to agree to
allow representatives of the Commission
or the broker-dealer’s DEA to review the
documentation associated with the
reports of the broker-dealer’s
independent public accountant and to
allow the accountant to discuss its
findings with the representatives, if
requested in writing for purposes of an
examination of the broker-dealer.660
Finally, the amendments require
broker-dealers to file a new Form
Custody, which elicits information
concerning the custody practices of the
broker-dealer.661 Form Custody must be
filed with the DEA each quarter. The
DEA must transmit the information
obtained from Form Custody to the
Commission at the same time that it
transmits FOCUS Report data to the
Commission under paragraph (a)(4) of
Rule 17a–5.
The burdens associated with the
collection of information requirements
in the amendments are discussed below.
B. Use of Information
The proposed amendments relating to
the reports to be filed by the brokerdealer are designed to enhance the
ability of the Commission to oversee
broker-dealer custody practices and,
among other things, to: (1) Increase the
focus of carrying broker-dealers and
their independent public accountants
on compliance, and internal control
over compliance, with the financial
responsibility rules; (2) facilitate the
ability of the PCAOB to implement the
explicit oversight authority of brokerdealer audits provided to the PCAOB by
the Dodd-Frank Act; and (3) with
respect to broker-dealers that are duallyregistered as investment advisers, satisfy
the internal control report requirement
659 See discussion above in section II.F. of this
release.
660 See discussion above in section III. of this
release.
661 See discussion above in section IV. of this
release.
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that was added by the amendment to
Rule 206(4)–2 noted above with the
accountant’s report based on an
examination of the compliance report.
Securities regulators will use these
reports to monitor the financial
condition of broker-dealers. In addition,
the components of the reports that are
made public may be used by investors
to review the financial condition of
broker-dealers with which they have
accounts or obtain other securities
related services. SIPC can use the
annual reports to monitor the financial
strength of broker-dealers and to assess
the adequacy of the SIPC Fund.
The amendment requiring a brokerdealer that clears transactions or carries
customer accounts to allow Commission
and DEA examination staff to review the
audit documentation associated with its
annual audit reports required under
Rule 17a–5 and to allow its independent
public accountant to discuss findings
relating to the audit reports with
Commission and DEA examination staff
is intended to facilitate examinations of
clearing broker-dealers by Commission
and DEA examination staff. Commission
and DEA examiners will use the
information obtained from audit
documentation and discussions with the
broker-dealer’s independent public
accountant to plan their examinations.
Finally, Commission and DEA
examiners will use Form Custody to
understand a broker-dealer’s custody
profile and identify custody-related
violations and misconduct. For
example, if a broker-dealer represents
on Form Custody that it does not issue
account statements, but an examiner
discovers that an account statement has
been issued by the broker-dealer (e.g., in
connection with a customer complaint
or in the course of an examination of the
broker-dealer), the examiner will be able
to react more quickly to the
misrepresentation. Further, the
requirement to prepare and file the form
should motivate broker-dealers to focus
more attention on their custody
practices.
C. Respondents
The Commission estimated in the
proposal that there were 5,063
registered broker-dealers that would be
affected by the proposed amendments
and that, of these, 305 were carrying
broker-dealers, 528 were carrying or
clearing broker-dealers, and 4,752 were
broker-dealers that claimed exemptions
from Rule 15c3–3.662 The Commission
did not receive comments regarding
these estimates, but the Commission has
662 See
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updated the estimates to reflect more
recent information.663
As of December 31, 2011, 4,709
broker-dealers filed FOCUS Reports
with the Commission. Of these, 4,417
broker-dealers claimed exemptions from
Rule 15c3–3. Consequently, the
Commission estimates that there are
approximately 292 carrying brokerdealers (4,709 ¥ 4,417 = 292). Based on
FOCUS Report data, the Commission
further estimates that there are
approximately 513 carrying or clearing
broker-dealers. According to SIPC, as of
March 31, 2012, 217 broker-dealers
claimed exemptions from SIPC
membership. Therefore, the
Commission estimates that 4,492 (4,709
¥ 217 = 4,492) broker-dealers are
members of SIPC.
D. Total Initial and Annual Burdens
As discussed in detail below, the
Commission estimates that the total
PRA burden resulting from the
amendments to Rules 17a–5 and 17a–11
and new Form Custody include an
initial, one-time burden of
approximately 13,522 hours 664 and an
annual burden of approximately
276,717 hours.665 There is significant
variance between the largest brokerdealers and the smallest broker-dealers.
Consequently, the estimates described
below are averages across all types of
broker-dealers expected to be affected
by the amendments.
1. Annual Reports To Be Filed
i. The Financial Report
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The Commission’s amendments to
Rule 17a–5 retain the current
requirement that broker-dealers
annually file financial statements and
supporting schedules that must be
audited by a PCAOB-registered
accountant. As a result, the
Commission’s estimate of the hour
burden for broker-dealers to prepare and
file the financial report has not changed
663 The updated estimates are based on FOCUS
Report data as of year end 2011. As discussed
above, FOCUS Reports are deemed confidential
pursuant to paragraph (a)(3) of Rule 17a–5.
664 As discussed below, the total one-time burden
relates to the requirement to draft and file a revised
statement regarding the independent public
accountant under Rule 17a–5(f)(2). The Commission
estimated a total one-time burden of 10,214 hours
in the proposing release for the statement regarding
the independent public accountant and for SIPC
forms. See Broker-Dealer Reports, 76 FR at 37595.
665 As discussed below, the total annual hour
burden relates to the compliance report (17,520
hours), the exemption report (30,919 hours), the
filing of annual reports with SIPC (2,246 hours),
and Form Custody (226,032 hours). The
Commission estimated a total annual burden of
287,325 hours in the proposing release. See BrokerDealer Reports, 76 at FR 37595.
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as a result of the amendments to Rule
17a–5.
ii. The Compliance Report
Under the amendments, a carrying
broker-dealer must prepare and file with
the Commission a new compliance
report each year. The compliance report
must contain statements as to whether:
(1) The broker-dealer has established
and maintained Internal Control Over
Compliance; (2) the Internal Control
Over Compliance of the broker-dealer
was effective during the most recent
fiscal year; (3) the Internal Control Over
Compliance of the broker-dealer was
effective as of the end of the most recent
fiscal year; (4) the broker-dealer was in
compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3 as of the
end of the most recent fiscal year; and
(5) the information the broker-dealer
used to state whether it was in
compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3 was
derived from the books and records of
the broker-dealer. In addition, if
applicable, the compliance report must
contain a description of: (1) Each
identified material weakness in the
broker-dealer’s Internal Control Over
Compliance during the most recent
fiscal year, including those that were
identified as of the end of the fiscal
year; and (2) any instance of noncompliance with Rule 15c3–1 or
paragraph (e) of Rule 15c3–3 as of the
end of the most recent fiscal year.
The Commission estimated that, on
average, carrying broker-dealers would
spend approximately 60 hours each year
to prepare the compliance report, as
proposed.666
One commenter stated that the
proposal did not ‘‘address the additional
costs broker-dealers would incur in
preparing Compliance Reports.’’667 The
commenter, however, did not comment
directly on the estimated hour burden or
provide specific examples of costs, in
addition to the hour burdens, that
broker-dealers would bear.668 Another
commenter also stated that the proposed
estimate of 60 hours ‘‘is not an accurate
estimate of the time burden to complete
the Compliance Report’’ and that the
burdens in the proposing release are
understated.669 The commenter stated
that completing the compliance report
will require extensive collaboration
between management, internal audit
and the independent public accountants
resulting in added hours to perform the
validation and evidence gathering of the
666 See
667 See
Broker-Dealer Reports, 76 FR at 37596.
SIFMA Letter.
existing processes necessary to make the
assertions in the proposed compliance
report.670 The commenter, however, did
not provide a different estimate of the
number of hours it would take to
complete the compliance report.
In response to these comments, the
Commission notes that the final rule
modifies the proposal in ways that may
modestly reduce the time burden. For
example, the final rule requires a
statement as to whether the brokerdealer was in compliance with Rule
15c3–1 and paragraph (e) of Rule 15c3–
3 as of the end of the most recent fiscal
year and, if applicable, a description of
any instances of non-compliance with
these rules as of the fiscal year end,
rather than the proposed assertion that
the broker-dealer is in compliance with
the financial responsibility rules in all
material respects and proposed
description of any material noncompliance with the financial
responsibility rules. This reflects two
changes from the proposal: (1)
Elimination of the concepts of ‘‘material
non-compliance’’ and ‘‘compliance in
all material respects’’ with Rule 15c3–1
and 15c3–3 for the purposes of reporting
in the compliance report; and (2) a
narrowing of these statements and
description requirements from
compliance with all of the financial
responsibility rules to compliance with
Rule 15c3–1 and paragraph (e) of Rule
15c3–3.
As modified, the final rule no longer
requires the broker-dealer to evaluate
whether an instance of non-compliance
with the financial responsibility rules
was material, a component of the
proposal that generated significant
comment. In addition, the broker-dealer
only needs to report instances of noncompliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3. In this
regard, broker-dealers currently are
required to include supporting
schedules to their financial statements
containing a computation of net capital
and the reserve requirement under
paragraph (e) of Rule 15c3–3.
Consequently, the work required under
this pre-existing requirement should
provide the broker-dealer with the
information it needs to make the
statement as to whether it is in
compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3 as of the
fiscal year end.
Given these modifications, the
statements in the compliance report
concerning the broker-dealer’s Internal
Control Over Compliance likely will be
responsible for the bulk of the hour
burden associated with preparing the
668 Id.
669 See
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compliance report. For example, the
broker-dealer will need to evaluate
whether its Internal Control Over
Compliance with the financial
responsibility rules was effective during
the most recent fiscal year.
The Commission believes that the
modifications to the final rule discussed
above may modestly reduce the hour
burden of the final rule as compared to
the hour burden that would have
resulted from the proposed rule;
namely, because a broker-dealer will not
need to evaluate whether instances of
non-compliance with the financial
responsibility rules are material and
will only need to report instances of
non-compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3. In light of
the comments suggesting that the
proposing release underestimated the
burden, the Commission is not reducing
the hour burden estimate for the rule to
reflect the potential reduction in hour
burden associated with the requirement.
Thus, to the extent the proposing release
underestimated the burden associated
with making the statements in the
compliance report about the brokerdealer’s Internal Control Over
Compliance, the amount of the burden
reduction realized through the
modifications discussed above is now
attributed to the burden associated with
the statements about Internal Control
Over Compliance.
For these reasons, the Commission is
retaining the rule’s overall hour burden
estimate without revision. The
Commission, however, is updating the
number of carrying broker-dealers to
reflect more recently available data from
the broker-dealer FOCUS Reports. The
Commission now estimates that there
are 292 carrying broker-dealers.
Consequently, the Commission
estimates that the total annual reporting
burden to prepare and file the
compliance report is approximately
17,520 hours per year for all carrying
broker-dealers.671
iii. The Exemption Report
Under the amendments, a noncarrying broker-dealer must file the
exemption report.672 In the exemption
report, the broker-dealer must provide
to its best knowledge and belief: (1) A
statement that identifies the provisions
in paragraph (k) of Rule 15c3–3 under
which the broker-dealer claimed an
exemption from Rule 15c3–3; (2) a
statement that the broker-dealer met the
671 60 hours × 292 carrying broker-dealers =
17,520 hours. See the discussion below regarding
the external costs associated with obtaining the
accountant’s report on the compliance report.
672 See discussion above in sections II.B.1. and
II.B.4. of this release.
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identified exemption provisions in
paragraph (k) throughout the most
recent fiscal year without exception or
that it met the identified exemption
provisions in paragraph (k) throughout
the most recent fiscal year except as
described in the exemption report; and
(3) if applicable, a statement that
identifies each exception during the
most recent fiscal year in meeting the
identified provisions in paragraph (k)
and that briefly describes the nature of
each exception and the approximate
date(s) on which the exception existed.
The Commission estimated that it
would take a non-carrying broker-dealer
approximately five hours to prepare and
file the proposed exemption report.673
The Commission did not receive any
comments on this hour estimate. As
discussed above in section II.B.4. of this
release, the Commission is adopting,
with modifications, the requirements
regarding the exemption report. These
provisions generally clarified the scope
and application of the report. However,
one modification provides that if the
broker-dealer states that it met the
identified exemption provisions in
paragraph (k) of Rule 15c3–3 throughout
the most recent fiscal year except as
described in the report, the brokerdealer must identify each exception
during the most recent fiscal year in
meeting the identified provisions in
paragraph (k) of Rule 15c3–3 and that
briefly describes the nature of each
exception and the approximate date(s)
on which the exception existed. The
Commission expects that non-carrying
broker-dealers generally track
exceptions as part of monitoring
compliance with the exemption
provisions in paragraph (k) of Rule
15c3–3. The requirement to identify and
describe exceptions would create an
incremental burden over the rule as
proposed. Based on staff experience
with the application of Rule 17a–5, the
Commission estimates that the
additional work associated with
describing exceptions in the exemption
report would take two hours. Therefore,
the Commission is revising the hour
estimate associated with the exemption
report to seven hours.
The Commission now estimates that
there are approximately 4,417 noncarrying broker-dealers that must file
exemption reports. Therefore, the
Commission estimates that the annual
reporting burden for all non-carrying
broker-dealers to prepare and file the
exemption report is approximately
30,919 hours per year.674
673 See
Broker-Dealer Reports, 76 FR at 37596.
hours × 4,417 non-carrying broker-dealers =
30,919 hours. See the discussion below regarding
674 7
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51961
iv. Additional Burden and Cost To File
the Annual Reports
The filing requirements for the annual
reports are being amended.675 In
particular, Rule 17a–5 previously
provided that a broker-dealer must file
two copies of its annual reports with the
Commission’s principal office in
Washington, DC. The final rule no
longer requires that two copies be filed,
so that, in accordance with paragraph
(d)(6) of Rule 17a–5, broker-dealers
must file only one copy of the annual
reports with the Commission’s principal
office. This change could reduce slightly
the hour burden and cost associated
with filing the annual reports with the
Commission.676
Amendments to paragraph (d)(6) of
Rule 17a–5 require that a broker-dealer
also file a copy of its annual reports
with SIPC. The Commission estimated
that it would take 30 minutes to prepare
an additional copy of the annual reports
and mail it to SIPC as required by the
proposed amendments.677 The
Commission did not receive comments
regarding this estimate. In addition, the
clarification to the final rule that only
broker-dealers that are members of SIPC
must file a copy of their annual reports
with SIPC will not affect the final PRA
hour burden estimate. Therefore, the
Commission is retaining this estimate
without revision. The Commission now
estimates that 4,492 broker-dealers are
members of SIPC.678 Therefore, the
Commission estimates that the annual
industry-wide reporting burden
associated with this amendment is
approximately 2,246 hours per year.679
There would be postage costs
associated with sending a copy of the
annual reports to SIPC that are
estimated to be, on average,680
approximately $12.05 per broker-dealer
the external costs associated with obtaining the
accountant’s report on the exemption report.
675 See discussion above in section II.B.6. of this
release.
676 The Commission does not expect the
compliance report, exemption report, and related
reports of the independent public accountant to
increase the mailing costs of the annual reports
because these additional reports in the aggregate
should not significantly increase the size and
weight of the package of annual reports.
677 See Broker-Dealer Reports, 76 FR at 37596.
678 As discussed in subsection C. above,
according to SIPC, as of March 31, 2012, 217 brokerdealers claimed exemptions from SIPC
membership. The Commission therefore estimates
that 4,492 (4,709¥217 = 4,492) broker-dealers are
members of SIPC.
679 1⁄2 hour × 4,492 broker-dealers = 2,246 hours.
680 The number of pages of an annual report, and
consequently the associated postage costs, likely
will vary significantly based on the size of the
broker-dealer and the types of business in which it
engages.
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per year.681 Thus, the Commission
estimates that the total annual postage
costs associated with sending a copy of
the annual reports to SIPC would be
approximately $54,128 per year for all
broker-dealers that are SIPC
members.682
Finally, the Commission notes that
paragraph (d)(1)(ii) of Rule 17a–5 of the
final rule was amended to require that
a copy of a DEA’s written approval to
change a broker-dealer’s fiscal year end
must be sent to the Commission’s
principal office in Washington DC, in
addition to the regional office of the
Commission for the region in which the
broker-dealer has its principal place of
business. Based on the number of copies
of approvals received by the
Commission and staff experience in the
application of Rule 17a–5, the
Commission estimates that
approximately 75 broker-dealers will
receive approval each year to change
their fiscal year end. The Commission
estimates that it would take 10 minutes
to copy and send an additional copy of
the approval to the Commission’s
principal office in Washington, DC for a
total industry-wide annual hour burden
of approximately 12.5 hours,683 and a
total industry-wide cost of
approximately $33.75 per year to mail
the approval.684
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v. Supplemental Report on SIPC
Membership
Prior to today’s amendments,
paragraph (e)(4) of Rule 17a–5 provided
that a broker-dealer must file with its
annual report a supplemental report on
the status of the membership of the
broker-dealer in SIPC, which was
required to be ‘‘covered by an opinion
of the independent public accountant’’
if the annual report of the broker-dealer
was required to be audited. The
Commission is adopting amendments to
681 Based on Commission staff experience with
annual report filings of broker-dealers under Rule
17a–5, the Commission staff estimates that
approximately 50% of broker-dealers file their
annual reports using an overnight mail delivery
service. These broker-dealers would consequently
incur higher postage costs than broker-dealers
which choose to mail their annual reports using
first class mail or delivery methods other than
overnight mail. Therefore, postage costs will vary
depending on the size of the annual report and
method of delivery. The Commission estimates that
the cost to mail the additional reports would be, on
average, $12.05 per broker-dealer. As of October
2012, the $12.05 rate is an average rate of the cost
of an Express Mail Flat Rate Envelope of $18.95 and
a Priority Mail Flat Rate Envelope of $5.15, based
on costs obtained on the Web site of the U.S. Postal
Service at: www.usps.gov. ($18.95 + $5.15) =
$24.10/2 = $12.05.
682 4,492 broker-dealers × $12.05 = $54,128.
683 (75 approvals × 10 minutes)/60 = 12.5 hours.
684 75 approvals × $0.45 (current price of a letter
sent first class) = $33.75.
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paragraph (e)(4) of Rule 17a–5 to
provide that broker-dealers must file
with SIPC—but no longer with the
Commission after an interim period if
SIPC adopts a rule under paragraph
(e)(4)(i) that is approved by the
Commission—a report of an
independent public accountant
designed to help administer the
collection of assessments from brokerdealers for purposes of establishing and
maintaining SIPC’s broker-dealer
liquidation fund.685 The Commission is
adopting the proposed amendments to
paragraph (e)(4) of Rule 17a–5
substantially as proposed. One
modification is that, as adopted, the
final rule provides that the accountant
must perform the procedures specified
in the rule in accordance with PCAOB
standards. SIPC may determine the
format of this report by rule, subject to
Commission approval.
Because broker-dealers are currently
required to file these reports with both
the Commission and SIPC, the final rule
amendment does not result in any
change to the Commission’s current
estimate of the hour burden for brokerdealers to comply with this requirement
under the current PRA collection for
Rule 17a–5. Although broker-dealers
will file the supplemental report on
SIPC membership only with SIPC if a
SIPC rule change to implement this
amendment is approved by the
Commission, as noted in the current
PRA collection, the variation in the size
and complexity of broker-dealers subject
to Rule 17a–5 makes it difficult to
calculate the burden of the information
collection of Rule 17a–5. Therefore, the
Commission will determine whether it
is appropriate to revise the PRA
estimate for Rule 17a–5 after any SIPC
rule filing is approved or after the end
of the two-year sunset provision.
In the proposing release the
Commission estimated, however, that
SIPC would incur a one-time burden
associated with filing a rule change with
the Commission to implement this
proposed amendment of approximately
100 hours.686 The process and
requirements for SIPC to file rule
changes with the Commission, however,
is set out in SIPA.687 Any burden on
685 See discussion above in section II.C.4. of this
release.
686 See Broker-Dealer Reports, 76 FR at 37597.
687 15 U.S.C. 78ccc(e)(2). The statute generally
requires that the Board of Directors of SIPC file with
the Commission a copy of any proposed rule change
accompanied by a concise general statement of the
basis and purpose of such proposed rule change. In
addition, the statute states that ‘‘the Commission
shall, upon the filing of any proposed rule change,
publish notice thereof, together with the terms of
substance of such proposed rule change or a
description of the subjects and issues involved’’ and
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SIPC to file a rule change with the
Commission would be associated with
the requirements under SIPA. Therefore,
the Commission is deleting the
proposed one-time 100 hours from the
final rule amendments.
vi. Statement Regarding Independent
Public Accountant
The Commission is amending
paragraph (f)(2) of Rule 17a–5 to revise
the statement regarding identification of
a broker-dealer’s independent public
accountant that broker-dealers must file
each year with the Commission and
their DEA (except that if the engagement
is of a continuing nature, no further
filing is required).688 The revised
statement contains additional
information that includes a
representation that the independent
public accountant has undertaken to
provide a report regarding the brokerdealer’s financial reports and a report
regarding the broker-dealer’s
compliance report or exemption report,
as applicable.689 In addition, the
statement provided by a clearing or
carrying broker-dealer must include
representations regarding the access to
its accountant requirements described
above.690 Therefore, all broker-dealers
will generally be required to file a new
statement regarding their independent
public accountant. The Commission
estimated that the one-time hour burden
associated with amending its existing
statement and filing the new statement
with the Commission, in order to
comply with the proposed amendments,
would be an average of approximately
two hours on a one-time basis for each
broker-dealer, as the statement can be
continuing in nature.691
The Commission is revising this
estimate for clearing and carrying
broker-dealers, as these broker-dealers
will likely need to renegotiate their
agreements with their independent
public accountants. The Commission
estimates, based on staff experience,
that it will take a carrying or clearing
broker-dealer approximately ten hours
on a one-time basis to renegotiate its
agreement with its accountant, amend
its statement regarding its accountant,
and file the new statement with the
Commission. The Commission estimates
that the one-time burden for all carrying
that the ‘‘Commission shall give interested persons
an opportunity to submit written data, views, and
arguments with respect to such proposed rule
change.’’ 15 U.S.C. 78ccc(e)(2)(A).
688 See discussion above in section III. of this
release.
689 See Rule 17a–5(f)(2)(ii). 17 CFR 240.17a–
5(f)(2)(ii).
690 See Rule 17a–5(f)(2)(ii)(F) and (G).
691 See Broker-Dealer Reports, 76 FR at 37596.
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or clearing broker-dealers is
approximately 5,130 hours 692 and the
one-time burden for all broker-dealers
that neither carry customer accounts nor
clear transactions is approximately
8,392 hours,693 for a total industry-wide
reporting burden of approximately
13,522 hours on a one-time basis.
Finally, the Commission believes
there will be postage costs associated
with sending the amended statement
regarding the accountant, which must
be sent to the Commission’s principal
office in Washington, DC, the regional
office of the Commission for the region
in which the broker-dealer’s principal
place of business is located, and to its
DEA. The Commission estimates that
each mailing will cost approximately
$0.45, for a total cost of approximately
$6,357 for all broker-dealers on a onetime basis.694
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vii. External Costs of Engagement of
Accountant
The amendments to Rule 17a–5 retain
the current requirement that brokerdealers annually file with the
Commission a financial report and a
report prepared by a PCAOB-registered
accountant based on an audit of the
financial report.695 However, the
financial report must be audited in
accordance with standards of the
PCAOB, instead of in accordance with
GAAS, as previously required. The
amendments also require a brokerdealer to file with the Commission
either a compliance report or an
exemption report and to obtain an
independent accountant’s report based
on an examination or review of those
reports, respectively.696
Broker-dealers incur annual external
costs associated with the PRA burden in
terms of hiring outside auditors and
accountants to comply with the
requirements of Rule 17a–5. Any
external costs of accountants’ reports
included in the PRA collection of
information for these final rule
amendments are averages across all
broker-dealers. The external PRA costs
incurred by a broker-dealer to comply
with the final rule amendments will
generally depend on its size and the
complexity of its business activities.
Because the size and complexity of
broker-dealers varies significantly, the
Commission provides estimates of the
hours × 513 carrying or clearing brokerdealers = 5,130 hours.
693 2 hours × 4,196 non-carrying and non-clearing
broker-dealers = 8,392 hours.
694 4,709 broker-dealers × $0.45 cost for first class
postage × 3 mailings = $6,357.15.
695 See discussion above in section II.D.3. of this
release.
696 Id.
692 10
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average external cost per broker-dealer
across all broker-dealers.697
The Commission received various
comments regarding the costs of the
proposed requirements and engagement
of the accountant provisions. More
specifically, the Commission received
comments addressing: (1) The costs of
the change from GAAS to PCAOB
standards for the financial report; (2) the
costs of the examination of the new
compliance report; and (3) the costs of
the review of the new exemption report.
The comments received with respect to
these three areas and the Commission’s
responses are addressed in detail in
each subsection below.
a. Financial Report (Including Change
From GAAS to PCAOB Standards)
Two commenters stated that the
Commission did not address the costs
associated with the change from GAAS
to PCAOB standards.698 These costs
would affect the external costs of
broker-dealers under the PRA burden to
the extent the change in standards
caused an increase in external
accounting fees incurred by brokerdealers. One commenter also stated that
the Commission may need to consider
the PCAOB’s proposed rules before it
can make a reasonable estimate, and
that transition to PCAOB standards may
require substantial revisions to audit
programs.699 Another commenter stated
that the economic analysis was
‘‘inconclusive’’ because the PCAOB has
not yet established auditing and
attestation standards for brokerdealers.700 In response to this comment,
the Commission estimates the costs of
its rules using the best information
available to it at the time.
Based on information currently
available, including the proposed
PCAOB standards, the Commission does
not expect that the move to PCAOB
standards for audits of broker-dealer
financial reports will result in
significant one-time implementation
costs or recurring annual costs. The
proposed PCAOB standards for audits of
financial reports (financial statements
and supporting schedules) generally
incorporate concepts and requirements
contained within GAAS, thereby
minimizing the potential costs to
broker-dealer auditors of this change. As
697 In the proposing release, these costs were
included in the Economic Analysis. The
Commission is also including these costs in the
PRA amendments to more accurately reflect
external costs incurred by broker-dealers as a result
of the PRA hour burdens imposed by the final rule
amendments, and in response to comments.
698 See, e.g., McGladrey Letter; SIFMA Letter.
699 See ABA Letter.
700 See CAI Letter.
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such, the Commission is not including
any additional external PRA costs
related to the change from GAAS to
PCAOB auditing standards.701 However,
in response to the comment, the
Commission will examine the effect of
any final PCAOB standards on the
external costs associated with this
collection of information in subsequent
extensions of this collection of
information and make any necessary
cost adjustments.
b. Compliance Report
The Commission estimated that the
incremental external cost to a carrying
broker-dealer of obtaining the
independent public accountant’s report
based on an examination of the
proposed compliance report would be
an average incremental cost of
approximately $150,000 per carrying
broker-dealer per year.702 The
Commission is including these external
costs in this collection of information.
One commenter stated that the
Commission underestimated the cost of
examining the compliance report.703
This commenter believed that the
auditing costs associated with the
compliance examinations were
underestimated given that the proposing
release contemplated a move from
GAAS to PCAOB auditing standards.704
This commenter stated that the
transition may require substantial
revisions to independent public
accountant audit programs, including
implementation of new auditing
techniques and processes and the
associated training programs and noted
that the proposed PCAOB standards
were not released until after the
publication of the proposing release.705
Another commenter stated that
completing both the compliance reports
and exemption reports ‘‘will require
extensive collaboration between
management, internal audit, and the
independent public accountants’’ and
that due to the ‘‘significant increase in
hours,’’ the proposed amendments have
‘‘the potential to double the total current
audit fees and have a material impact’’
on firms.706 These commenters did not
quantify their cost estimates in terms of
dollars; nor did they provide data to
support their conclusions.
As explained above in section II.D. of
this release, before today’s amendments,
Rule 17a–5 required a broker-dealer to
701 See section VII. of this release (discussing
benefits and costs of changing from GAAS to
PCAOB auditing standards).
702 See Broker-Dealer Reports, 76 FR at 37599.
703 See ABA Letter.
704 Id.
705 Id.
706 See Van Kampen/Invesco Letter.
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engage an independent public
accountant to prepare a material
inadequacy report based on, among
other things, a review of the accounting
system, internal accounting control, and
procedures for safeguarding securities of
the broker-dealer, including appropriate
tests, for the period since the prior
examination date. In addition, the
accountant was required to review the
practices and procedures followed by
the broker-dealer in, among other
things, (1) making periodic
computations of net capital and under
paragraph (e) of Rule 15c3–3, (2) making
quarterly securities examinations,
counts, verifications, and comparisons
under Rule 17a–13, and (3) obtaining
and maintaining physical possession or
control of all fully paid and excess
margin securities of customers as
required by Rule 15c3–3.
Consequently, under requirements
before today’s amendments relating to a
material inadequacy report that are
being replaced by the examination of
the compliance report, the broker-dealer
was required to engage the independent
public accountant to review the internal
controls, practices, and procedures of
the broker-dealer with respect to key
elements of the financial responsibility
rules.
For these reasons, the Commission
continues to believe that the average
incremental cost of $150,000 per
carrying broker-dealer to obtain the
accountant’s report covering the
compliance report is reasonable.
Moreover, as stated above, the
Commission is adopting the proposed
amendments to Rule 17a–5 with respect
to the compliance report with
modifications. For example, the final
rule requires a statement as to whether
the broker-dealer was in compliance
with Rule 15c3–1 and paragraph (e) of
Rule 15c3–3 as of the end of the most
recent fiscal year and, if applicable, a
description of any instances of noncompliance with these rules as of the
fiscal year end, rather than the proposed
assertion that the broker-dealer is in
compliance with the financial
responsibility rules in all material
respects and the proposed description of
any material non-compliance with the
financial responsibility rules. This
reflects two changes from the proposal:
(1) Elimination of the concepts of
‘‘material non-compliance’’ and
‘‘compliance in all material respects’’
with Rule 15c3–1 and 15c3–3 for the
purposes of reporting in the compliance
report; and (2) a narrowing of these
statements and description
requirements from compliance with all
of the financial responsibility rules to
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compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3.
As modified, the final rule no longer
requires the independent public
accountant to evaluate whether an
instance of non-compliance with the
financial responsibility rules was
material. While there may be an
increase in the number of reported
instances of non-compliance than under
the proposal, the independent public
accountant will not be required to
determine whether an instance of noncompliance is material. Consequently,
the reporting of instances of noncompliance (as compared to instances of
material non-compliance) is not
expected to increase costs of the
engagement of the accountant from
those estimated for the proposal and
may decrease costs.
In addition, the final rule has been
modified from the proposal so that the
independent public accountant will not
be required to examine a broker-dealer
statement that encompassed compliance
with all the financial responsibility
rules. Instead, the independent public
accountant must examine a statement
about compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3. In this
regard, the Commission has not
amended the requirement, which
existed before today’s amendments, that
the independent public accountant
examine the supporting schedules to the
broker-dealer’s financial statements,
which contain a computation of net
capital under Rule 15c3–1 and the
reserve requirement under paragraph (e)
of Rule 15c3–3.
Given these modifications, the
statements in the compliance report
concerning the broker-dealer’s Internal
Control Over Compliance will likely
account for the bulk of the work of the
independent public accountant and, as
noted above, before today’s
amendments, the independent public
accountant was required to include
internal control within the scope of the
audit.
The Commission believes that the
modifications to the final rule discussed
above should modestly reduce the
external cost of the final rule as
compared to the cost that would have
resulted from the proposed rule.
Further, elimination of the requirement
that the accountant prepare a material
inadequacy report will result in some
cost savings.707 While these
707 The Commission also stated in the proposing
release that the Commission estimated that
amendments to the IA Custody Rule would impose
external costs of $250,000 per investment adviser,
and that the Commission estimated that the
examination of the compliance report would
incrementally cost $150,000 because the IA Custody
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modifications to the final rule may
result in reduced costs, the Commission
continues to believe that the average
estimated incremental cost of $150,000
per carrying broker-dealer, which may
be at the high end of the range of
estimated costs, is reasonable.
For these reasons, the Commission
has not changed its average estimate of
the incremental cost of the accountants’
reports covering the compliance report.
The Commission therefore estimates
that the average industry-wide annual
external reporting incremental cost of
this requirement is approximately
$43,800,000 per year ($150,000 × 292
carrying broker-dealers = $43,800,000).
c. Exemption Report
The Commission estimated that the
external cost to a non-carrying brokerdealer of obtaining the independent
public accountant’s report based on a
review of the proposed exemption
report would be an average of
approximately $3,000 per non-carrying
broker-dealer per year, for a total
estimated annual cost associated with
this proposal of $14,256,000.708 The
Commission did not receive any specific
comments regarding this cost estimate.
In the proposing release, the
Commission stated its belief that an
independent public accountant’s review
of the exemption assertion would add
an incremental cost to that incurred as
a result of the annual financial audit.709
As discussed above, independent public
accountants engaged by broker-dealers
were required, before today’s
amendments, to ‘‘ascertain that the
conditions of the exemption were being
complied with as of the examination
date and that no facts came to [the
independent public accountant’s]
attention to indicate that the exemption
had not been complied with during the
period since [the independent public
accountant’s] last examination.’’ 710
The Commission continues to believe
that $3,000 is a reasonable estimate of
the cost of obtaining the accountant’s
report covering the exemption report.
The Commission now estimates that
Rule imposed new requirements on investment
advisers, and, unlike the final rule amendments
being adopted today, was not based on existing
obligations. See Broker-Dealer Reports, 76 FR at
37599. Based on this comparison, the Commission
continues to believe that the average estimated
incremental cost of $150,000 per carrying brokerdealer is reasonable and that the changes discussed
above generally should not materially impact the
cost estimate as they may, in some cases, result in
a modest reduction in burden.
708 See Broker-Dealer Reports, 76 FR at 37599–
37600. The Commission estimated that there were
4,752 non-carrying broker-dealers. 4,752 × $3,000 =
$14,256,000.
709 Id. at 37599.
710 See 17 CFR 240.17a–5(g)(2).
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there are approximately 4,417 noncarrying broker-dealers. The
Commission therefore estimates that the
total industry-wide external annual
reporting cost of this requirement is
approximately $13,251,000 per year
(4,417 non-carrying broker-dealers ×
$3,000 = $13,251,000).
d. Access to Accountant and Audit
Documentation
The amendments to Rule 17a–5
require that carrying or clearing brokerdealers agree to allow Commission and
DEA staff, if requested in writing for
purposes of an examination of the
broker-dealer, to review the work papers
of the independent public accountant
and to allow the accountant to discuss
its findings with the examiners.
In the proposing release, the
Commission estimated that a carrying or
clearing broker-dealer’s accountant
would charge the broker-dealer for time
its personnel spend speaking with the
Commission or the broker-dealer’s DEA
and providing them with audit
documentation.711 Thus, the
Commission estimated that the
additional cost of accountant time
associated with this amendment to all
clearing and carrying broker-dealers
would be approximately $660,000
annually.712 As the Commission now
estimates that the number of carrying or
clearing broker-dealers is 513, the new
estimate is approximately $641,250.713
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2. Conforming and Technical
Amendments to Rule 17a–11
The Commission proposed technical
amendments to Rule 17a–5 and
proposed amending paragraph (e) of
Rule 17a–11 to eliminate a reference to
Rule 17a–5.714 The Commission stated
that these changes should not result in
an additional hour burden for the Rule
17a–11 collection of information. As
discussed above in section II.F.2. of this
release, in response to a comment,
paragraph (e) of Rule 17a–11, as
adopted, retains a reference to Rule 17a–
5. In addition, the Commission is
adopting conforming amendments to
substitute the term material weakness as
defined in paragraph (d)(3)(iii) of Rule
17a–5 for the term material inadequacy
with respect to Rule 17a–5. Specifically,
711 In the proposing release, the Commission
estimated that a broker-dealer’s accountant would
spend approximately 5 hours per year speaking
with Commission or DEA staff and providing them
with audit documentation.
712 In the proposing release, the Commission
multiplied 528 clearing and carrying broker-dealers
× 5 hours × $250/hour = $660,000.
713 513 clearing and carrying broker-dealers ×
$1,250 in increased costs per clearing broker-dealer
= $641,250.
714 See Broker-Dealer Reports, 76 FR at 37597.
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the final rule provides that whenever a
broker-dealer discovers, or is notified by
its accountant under paragraph (h) of
Rule 17a–5 of the existence of any
material weakness, the broker-dealer
must: (1) Give notice of the material
weakness within 24 hours of the
discovery or notification; and (2)
transmit a report within 48 hours of the
notice stating what the broker-dealer has
done or is doing to correct the
situation.715
The Commission does not expect any
change in the number of notices filed
per year as a result of the final
amendments because the material
inadequacy notification requirement is
being replaced by a material weakness
notification requirement. Therefore, the
final amendments to Rule 17a–11
should not result in a change in the
current PRA burden for Rule 17a–11.
However, the Commission will take into
account any changes in the number of
notices associated with this collection of
information in subsequent extensions of
this collection of information and make
any necessary adjustments, as
appropriate.
3. Form Custody
As described more fully above, the
amendments require that all brokerdealers registered with the Commission
file Form Custody quarterly with their
DEA. The Commission estimated that
the hour burden associated with
completing and filing proposed Form
Custody would be approximately 12
hours per quarter, or 48 hours per year,
on average, for each broker-dealer.716
In section IV. of this release, in
adopting the final amendments to Form
Custody, the Commission received one
comment in response to Item 8 of Form
Custody, as proposed, noting that the
information sought in Item 8 was largely
the same as information collected from
investment advisers on Form ADV.717
As stated above in section IV. of this
release, the Commission is aware that
some overlap exists between the
information collected from investment
advisers on Form ADV and the
information that would be collected
from broker-dealers dually-registered as
investment advisers in Item 8 of
proposed Form Custody. However, these
two forms also contain a significant
amount of non-overlapping material,
reflecting their different purposes and
uses. Form Custody is intended to be a
single source of readily-available
715 See paragraph (e) of Rule 17a–11. This
provision retains references to material inadequacy
with respect to Rule 17a–12.
716 See Broker-Dealer Reports, 76 FR at 37597.
717 See Angel Letter.
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51965
information to assist Commission and
DEA examiners in preparing for and
performing focused custody exams, and
it is particularly important that such
information be readily available in the
case of dually-registered firms.
Consequently, the Commission believes
that the PRA burden for Form Custody
is reasonable in light of its intended
purpose, as discussed above in section
IV. of this release. Additionally, the
commenter did not indicate
disagreement with the hour burden
estimate as proposed. Therefore, the
Commission is retaining the hour
burden estimate without revision.
The Commission now estimates that
there are approximately 4,709 brokerdealers that must file Form Custody.
The Commission therefore estimates
that the total annual burden associated
with completing and filing Form
Custody for all 4,709 broker-dealers is
approximately 226,032 hours per year
(4,709 broker-dealer times 4 responses
per year times 12 hours = 226,032
hours).
One commenter stated that the
estimated costs to the industry of
$69,179,670 is ‘‘staggering,’’ and that
such costs would likely indirectly be
passed on to customers.718 The
commenter did not disagree with the
PRA estimate in the proposing release;
rather, the commenter focused on size of
the total estimated costs. The
Commission recognizes that the
requirement to file Form Custody will
increase compliance costs for brokerdealers and, consequently, the PRA
estimates reflect these costs. The PRA
hour burden estimates (and associated
internal burden costs), however, are
averages across all broker-dealers. The
costs incurred by a broker-dealer to
comply with the requirement to file
Form Custody will depend on its size
and the complexity of its business
activities. Because the size and
complexity of broker-dealers varies
significantly, the Commission provides
estimates of the average cost per brokerdealer across all broker-dealers.
For these reasons, the Commission
believes the internal costs related to the
PRA for this hour burden are reasonable
and, therefore, the Commission is not
adjusting the final cost estimate, except
to reflect updated data with respect to
718 See IMS Letter. The cost of $69,179,670 was
reflected in the Economic Analysis in the proposing
release. See Broker-Dealer Reports, 76 FR at 37601.
This cost was calculated as an internal cost of the
estimated PRA hours and is the total cost divided
among 5,057 firms. Id. at 37601 n.215. This internal
cost would amount to an average of $13,680 per
broker-dealer.
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the number of broker-dealers and
compensation.719
E. Collection of Information Is
Mandatory
The collection of information
obligations imposed by the rule
amendments are mandatory for brokerdealers that are registered with the
Commission.
F. Confidentiality
The Commission expects to receive
confidential information in connection
with the proposed collections of
information. Paragraph (e)(3) of Rule
17a–5, as amended, provides that
broker-dealer annual reports filed with
the Commission are not confidential,
except that if the Statement of Financial
Condition is bound separately from the
balance of the annual reports, and each
page of the balance of the annual reports
is stamped ‘‘confidential,’’ then the
balance of the annual reports shall be
deemed confidential to the extent
permitted by law.720 However, under
paragraph (c)(2)(iv) of Rule 17a–5, if
there are material weaknesses, the
accountant’s report on the compliance
report must be made available for
customers’ inspection and,
consequently, it would not be deemed
confidential. In addition, paragraph
(c)(2)(i) of Rule 17a–5 requires a brokerdealer to furnish to its customers
annually a balance sheet with
appropriate notes prepared in
accordance with GAAP and which must
be audited if the broker-dealer is
required to file audited financial
statements with the Commission.721
With respect to the other information
collected under the amendments, a
broker-dealer can request the
confidential treatment of the
information.722 If such a confidential
treatment request is made, the
Commission anticipates that it will keep
the information confidential to the
extent permitted by law.723
VII. Economic Analysis
The Commission is sensitive to the
costs and benefits of its rules. When
engaging in rulemaking that requires the
Commission to consider or determine
whether an action is necessary or
appropriate in the public interest,
section 3(f) of the Exchange Act requires
that the Commission consider, in
addition to the protection of investors,
whether the action will promote
efficiency, competition, and capital
formation.724 In addition, section
23(a)(2) of the Exchange Act requires
that the Commission consider the effects
on competition of any rules the
Commission adopts under the Exchange
Act, and prohibits the Commission from
adopting any rule that would impose a
burden on competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act.725
In the proposing release, the
Commission solicited comment on the
costs and benefits of the proposed
amendments and new form, including
whether estimates of the costs and
benefits were accurate and
comprehensive.726 The Commission
further encouraged commenters to
provide specific data and analysis in
support of their views.727 The
Commission also requested comment on
whether the proposed amendments
would place a burden on competition,
and promote efficiency, competition,
and capital formation.728
The Commission received 27
comment letters on the proposed
amendments. A number of commenters
addressed the Commission’s estimates
of the cost and benefits of the proposed
amendments.729 Generally, these
commenters stated that the
Commission’s cost and benefit estimates
failed to include all of the costs
associated with the proposed
amendments and that the costs that the
Commission did include in its analysis
were underestimated. For example, one
commenter stated that the proposed
amendments ‘‘place unnecessary
regulatory burdens and costs on
industry, in general, and smaller firms,
in particular’’ and that ‘‘broker-dealers
compete against investment advisers
who are not burdened by the same
regulatory requirements,’’ including the
requirements in the proposed
amendments.730 While commenters
stated that the Commission
underestimated costs, they did not
724 15
U.S.C. 78c(f).
U.S.C. 78w(a)(2).
726 See Broker-Dealer Reports, 76 FR at 37598. An
economic analysis was included in the proposing
release. Id. at 37598–37601.
727 Id. at 37598.
728 Id.
729 See ABA Letter; AICPA Letter; Angel Letter;
CAI Letter; Citrin Letter; IMS Letter; KPMG Letter;
McGladrey Letter; SIFMA Letter; Van Kampen/
Invesco Letter.
730 See IMS Letter.
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725 15
719 Id.
720 See
paragraph (e)(3) of Rule 17a–5.
721 See 17 CFR 240.17a–5(c)(2)(i).
722 See 17 CFR 200.83. Information regarding
requests for confidential treatment of information
submitted to the Commission is available at
https://www.sec.gov/foia/howfo2.htm#privacy.
723 See, e.g., 15 U.S.C. 78x (governing the public
availability of information obtained by the
Commission); 5 U.S.C. 552 et seq.
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provide alternative quantified estimates
of the costs.731
As discussed throughout this release,
in part in response to comments, the
Commission has modified the proposed
rules to reduce compliance burdens
where consistent with investor
protection. In addition, as discussed
below, where commenters identified
costs the Commission did not consider,
the Commission has revised its
economic analysis of the final rules to
take these costs into account.
In adopting the rule amendments and
new form, the Commission has been
mindful of the associated costs and
benefits. The costs and benefits that the
Commission has considered in adopting
these amendments and new form are
discussed below. The discussion
focuses on the Commission’s reasons for
adopting these amendments and new
form, the affected parties, and the costs
and benefits of the amendments and
new form compared to the baseline,
described below, and to alternative
courses of action.
Many of the benefits and costs
discussed below are difficult to
quantify, in particular when discussing
increases in investor confidence and
improvements in investor protection.
For example, the extent to which the
increased ability of the Commission and
DEAs to oversee compliance with the
financial responsibility rules will help
limit future violations of the rules is
unknown. Similarly, it is unknown how
much increasing the focus of brokerdealers on the financial responsibility
rules will result in enhanced
compliance with those rules. Moreover,
limited public data exists to study the
costs of broker-dealer audits. Therefore,
much of the discussion is qualitative in
nature but, where possible, the
Commission attempted to quantify the
costs.
A. Motivation for the Amendments
The rule amendments and new form
being adopted today are designed to
provide additional safeguards with
respect to broker-dealer custody of
customer securities and funds. The
motivation for these amendments,
which are discussed throughout this
release, are summarized below.
731 For example, one commenter stated that the
Commission’s estimate of the costs of the
compliance report have ‘‘the potential to double the
total current audit fees and have a material impact’’
on firms. See Van Kampen/Invesco Letter. The
commenter, however, did not provide a quantified
baseline estimate of current audit fees incurred by
broker-dealers with which to compare the
Commission’s estimate of the incremental cost that
the compliance report amendments will have on
audit fees.
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First, as mentioned above in section
I.A. of this release, over the last several
years, the Commission has brought
several cases alleging fraudulent
conduct by investment advisers and
broker-dealers, including among other
things, alleged misappropriation or
other misuse of customer securities and
funds.732 These cases highlight the need
for enhancements to the rules governing
broker-dealer custody of customer
assets. Such enhancements include both
increased focus on compliance and
internal compliance controls by brokerdealers and their auditors, as well as
measures to increase the ability of the
Commission and broker-dealer DEAs to
oversee broker-dealer custody practices
by requiring broker-dealers to provide
more information about these practices.
Second, as discussed above in section
II.D. of this release, certain provisions of
Rule 17a–5 before today’s amendments
were inconsistent with current audit
practices, standards, and terminology,
which have evolved since these
provisions were adopted. This
inconsistency has resulted in disparate
audit practices and inconsistent
compliance with the rule. As discussed
above in section II.D.3.iii. of this release,
the PCAOB has published a report
containing observations from
inspections of portions of 23 brokerdealer audits conducted by ten
accounting firms.733 According to the
report, PCAOB inspections staff
identified deficiencies in all of the
audits inspected.734 The deficiencies
noted in the report provide support for
the need to strengthen and clarify
broker-dealer audit and reporting
requirements in order to facilitate
consistent compliance with these
requirements.
Third, as discussed in section II.D. of
this release, prior to today’s
amendments, Rule 17a–5 required that
broker-dealer audits be conducted in
accordance with GAAS, which are
established by the Auditing Standards
Board of the AICPA. The amendments—
by requiring that the audits be
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732 See,
e.g., SEC v. Donald Anthony Walker
Young, et al., Litigation Release No. 21006 (Apr. 20,
2009); SEC v. Isaac I. Ovid, et al., Litigation Release
No. 20998 (Apr. 14, 2009); SEC v. The Nutmeg
Group, LLC, et al., Litigation Release No. 20972
(Mar. 25, 2009); SEC v. WG Trading Investors, L.P.,
et al., Litigation Release No. 20912 (Feb. 25, 2009);
SEC v. Stanford International Bank, et al.,
Litigation Release No. 20901 (Feb. 17, 2009); SEC
v. Bernard L. Madoff, et al., Litigation Release No.
20889 (Feb. 9, 2009). The Commission also has
brought an enforcement action against an
accountant that purported to audit financial
statements and disclosures of one of these brokerdealers. See SEC v. David G. Friehling, C.P.A., et al.,
Litigation Release No. 20959 (Mar. 18, 2009).
733 See PCAOB Inspection Report at p. ii.
734 Id.
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conducted in accordance with PCAOB
standards—recognize the PCAOB’s
explicit oversight authority over brokerdealer audits as provided by the DoddFrank Act, including the authority to
establish (subject to Commission
approval) and enforce auditing and
related attestation, quality control,
ethics, and independence standards.735
In addition, the Commission has direct
oversight authority over the PCAOB,
including the authority to approve or
disapprove the PCAOB’s rules and
standards.736 Consequently, requiring
that broker-dealer audits be conducted
in accordance with standards the
Commission has approved will better
ensure alignment between broker-dealer
audits and the regulatory policy
objectives reflected in the Commission’s
financial responsibility rules.
Fourth, as discussed in section II.B.6.
of this release, because broker-dealers
have not been required to file with SIPC
their annual audited financial
statements, SIPC has received limited
information regarding the financial
condition of its broker-dealer members.
SIPC can use this information, among
other things, to assess whether the SIPC
Fund is appropriately sized to the risks
of a large broker-dealer failure. In
addition, at least one court, the New
York Court of Appeals, has held that in
cases where SIPC is required to fund the
liquidation of a broker-dealer, SIPC
could not maintain a claim against the
auditor of the broker-dealer based on an
alleged failure to comply with auditing
standards because SIPC did not receive
the audited financial statements and
therefore could not have relied upon
them.
Fifth, as discussed in section III. of
this release, the audit work performed
by independent public accountants with
respect to audits of carrying and
clearing broker-dealers can provide
useful information to Commission and
DEA examiners in terms of planning the
scope and focus of the examination of
the broker-dealer. Providing
Commission and DEA examiners with
access to the independent public
accountant that audited the broker735 See
discussion in section II.D.3. of this release.
107(a) of the Sarbanes-Oxley Act
provides that the Commission ‘‘shall have oversight
and enforcement authority over the [PCAOB] as
provided by the [Sarbanes-Oxley Act].’’ Section
107(b) of the Sarbanes-Oxley act provides that ‘‘[n]o
rule of the [PCAOB] shall become effective without
prior approval of the Commission’’ other than
certain initial or transitional standards. Section
107(c) of the Sarbanes-Oxley Act provides for
Commission review of disciplinary action taken by
the PCAOB. Section 107(d) of the Sarbanes-Oxley
Act provides that the Commission may censure and
impose other sanctions on the PCAOB in certain
circumstances.
736 Section
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51967
dealer and audit documentation related
to the audit will allow the examiners to
gain an understanding of the work the
accountant did in auditing the brokerdealer and any areas of concern
highlighted by the auditor. This will
enable the examiners to conduct riskbased examinations of carrying and
clearing broker-dealers and assist the
examiners in determining areas of focus
for their examinations. Furthermore, the
amendments will make it clear to the
independent public accountant that the
broker-dealer has agreed that the
accountant can provide this information
and, consequently, eliminate
uncertainty as to whether the brokerdealer consents to the disclosure of the
information.
Sixth, as discussed in section IV. of
this release, because broker-dealers were
not required to provide comprehensive
or consolidated information about their
custody practices to the Commission or
their DEA, the Commission and the
broker-dealer’s DEA had a fragmented
and incomplete picture of whether a
broker-dealer maintained custody of
customer and non-customer assets, and
if so, how such assets were maintained.
This hindered the ability of the
Commission and DEAs to efficiently
plan, prioritize, and perform
examinations.
B. Economic Baseline
The regulatory changes adopted today
amend requirements that apply to
broker-dealers registered with the
Commission and independent public
accountants that audit or attest to
broker-dealer annual reports. The
discussion below includes approximate
numbers of broker-dealers and
accountants that would be affected by
today’s amendments and a description
of the economic baseline against which
the costs and benefits, as well as the
impact on efficiency, competition, and
capital formation, of today’s
amendments and new form are
measured.
1. Broker-Dealers
The broker-dealers registered with the
Commission vary significantly in terms
of their size, business activities, and the
complexity of their operations. For
example, carrying broker-dealers hold
customer securities and funds.737
737 Rule 15c3–1, the Commission’s net capital
rule, specifies that a broker-dealer shall be deemed
to carry customer or broker-dealer accounts ‘‘if, in
connection with its activities as a broker or dealer,
it receives checks, drafts, or other evidences of
indebtedness made payable to itself or persons
other than the requisite registered broker or dealer
carrying the account of a customer, escrow agent,
issuer, underwriter, sponsor, or other distributor of
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Clearing broker-dealers clear
transactions as members of security
exchanges and the Depository Trust &
Clearing Corporation and the Options
Clearing Corporation.738 Many clearing
broker-dealers are carrying brokerdealers, but some clearing brokerdealers clear only their own transactions
and do not hold customer securities and
cash.
As stated in section I.B.1. above, a
broker-dealer that claims an exemption
from Rule 15c3–3 is generally referred
to as ‘‘non-carrying broker-dealer.’’ Noncarrying broker-dealers include
‘‘introducing brokers.’’ 739 These noncarrying broker-dealers accept customer
orders and introduce their customers to
a carrying broker-dealer that will hold
the customers’ securities and cash along
with the securities and cash of
customers of other introducing brokerdealers and those of direct customers of
the carrying broker-dealer. The carrying
broker-dealer generally receives and
executes the orders of the introducing
broker-dealer’s customers.740 Carrying
broker-dealers also prepare trade
confirmations, settle trades, and
organize book entries of the
securities.741 Introducing broker-dealers
also may use carrying broker-dealers to
clear the firm’s proprietary trades and
carry the firm’s securities. Another
group of non-carrying broker-dealers
effects transactions in securities such as
mutual funds on a subscription-way
basis, where customers purchase the
securities by providing the funds
directly to the issuer. 742 Finally, some
non-carrying broker-dealers act as
finders by referring prospective
purchasers of securities to issuers.743
The broker-dealer industry is the
primary industry affected by the rule
amendments and the new form. In some
cases, the amendments impose different
requirements on different types of
broker-dealers. For example, carrying
broker-dealers must file the compliance
report and an independent public
accountant’s report covering the
compliance report, while non-carrying
broker-dealers must file the exemption
report and an independent public
accountant’s report covering the
exemption report. Only carrying and
clearing broker-dealers must agree to
allow Commission and DEA examiners
to review the audit documentation of
their independent public accountants
and to allow accountants to discuss
their findings with the examiners. All
broker-dealers must file Form Custody,
but many of the line items on the form
apply only to carrying broker-dealers.
To establish a baseline for
competition among broker-dealers, the
Commission looks at the status of the
broker-dealer industry detailed below.
In terms of size, the following tables
illustrate the variance among brokerdealers with respect to total capital. The
information in the table is based on
FOCUS Report data for calendar year
2011.
BROKER-DEALER CAPITAL AT CALENDAR YEAR END 2011744
[$ millions]
Capital
Number of firms
Aggregate total
capital
Less than $500,000 .....................................................................................................................................
Greater than or equal to $500,000 and less than $5 million ......................................................................
Greater than or equal to $5 million and less than $50 million ....................................................................
Greater than or equal to $50 million and less than $100 million ................................................................
Greater than or equal to $100 million and less than $500 million ..............................................................
Greater than or equal to $500 million and less than $1 billion ...................................................................
Greater than or equal to $1 billion and less than $5 billion ........................................................................
Greater than or equal to $5 billion and less than $10 billion ......................................................................
Greater than or equal to $10 billion ............................................................................................................
2,506
1,320
608
80
125
28
27
6
9
$347
2,212
10,520
5,672
26,655
19,248
61,284
41,175
175,585
Total ......................................................................................................................................................
4,709
342,698
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According to FOCUS Report data, as
of December 31, 2011, there were
approximately 4,709 broker-dealers
registered with the Commission.745 Nine
broker-dealers dominate the brokerdealer industry, holding over half of all
capital held by broker-dealers. Of the
4,709 registered broker-dealers, 4,417
firms claimed exemptions from Rule
15c3–3 on their FOCUS Reports.
Accordingly, the Commission estimates
that there are approximately 292
securities’’ or ‘‘if it does not promptly forward or
promptly deliver all of the securities of customers
or of other brokers or dealers received by the firm
in connection with its activities as a broker or
dealer.’’ 17 CFR 240.15c3–11(a)(2)(i). Further, Rule
15c3–3, the Commission’s customer protection rule
governing reserves and custody of securities,
defines the term ‘‘securities carried for the account
of a customer’’ to mean ‘‘securities received by or
on behalf of a broker or dealer for the account of
any customer and securities carried long by a broker
or dealer for the account of any customer,’’ as well
as securities sold to, or bought for, a customer by
a broker-dealer. 17 CFR 240.15c3–3(a)(2).
738 See Definitions of Terms and Exemptions
Relating to the ‘‘Broker’’ Exceptions for Banks, Final
Rule, Exchange Act Release No. 56501 (Sept. 24,
2007), 72 FR 56514, 56541 n.269 (Oct. 3, 2007).
739 Id. at ¶ 1.15; see also Exchange Act Release
No. 31511 (Nov. 24, 1992), 57 FR 56973 (Dec. 2,
1992) (describing role of introducing brokerdealers).
740 Exchange Act Release No. 31511 (Nov. 24,
1992), 57 FR 56973 (Dec. 2, 1992).
741 See, e.g., FINRA Rule 4311 (Carrying
Agreements). This FINRA rule governs the
requirements applicable to FINRA members when
entering into agreements for the carrying of any
customer accounts in which securities transactions
can be effected. Historically, the purpose of this
rule has been to ensure that certain functions and
responsibilities are clearly allocated to either the
introducing or carrying firm, consistent with the
requirements of the SRO’s and Commission’s
financial responsibility and other rules and
regulations, as applicable. See also Notice of Filing
of Amendment No. 1 and Order Granting
Accelerated Approval of a Proposed Rule Change
Adopting, as Modified by Amendment No. 1, Rules
Governing Guarantees, Carrying Agreements,
Security Counts and Supervision of General Ledger
Accounts in the Consolidated FINRA Rulebook,
Exchange Act Release 34–63999 (Mar. 7, 2011), 76
FR 12380 (Mar. 7, 2011).
742 See Books and Records Requirement for
Brokers and Dealers Under the Securities Exchange
Act of 1934, Exchange Act Release 34–44992 (Nov.
2, 2001) (‘‘[T]he Commission recognizes that for
some types of transactions, such as purchases of
mutual funds or variable annuities, the customer
may simply fill out an application or a subscription
agreement that the broker-dealer then forwards
directly to the issuer.’’).
743 See American Bar Association, Report and
Recommendations of the Task Force on Private
Placement Broker-Dealers 23–24 (2005); see also
Exchange Act Release No. 31511 (Nov. 24, 1992),
57 FR 56973 (Dec. 2, 1992).
744 The information in this chart is based on
FOCUS Report data filed by broker-dealers in 2011.
745 Not all broker-dealers registered with the
Commission are SIPC members. According to SIPC,
as of March 31, 2012, 217 broker-dealers claimed
exemptions from SIPC membership. The
Commission therefore estimates that 4,492 (4,709 ¥
217 = 4,492) broker-dealers are members of SIPC.
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carrying broker-dealers (4,709¥4,417 =
292). Further, based on FOCUS Report
data, the Commission also estimates that
there are approximately 513 brokerdealers that are clearing or carrying
firms. The Commission staff has
estimated that approximately 18% of
broker-dealers registered with FINRA 746
also are registered as investment
advisers with the Commission or with a
state.747
2. Independent Public Accountants That
Audit Broker-Dealer Reports
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Independent public accountants that
audit broker-dealer reports also will be
impacted by the rule amendments.
Based on the audit reports filed by
broker-dealers in 2011, approximately
900 accounting firms audited brokerdealer reports that were filed with the
Commission. However, six large
accounting firms dominate the market
performing audits for approximately
20% of all broker-dealers registered
with the Commission, and those brokerdealers audited by the six large
accounting firms had total capital that
was more than 90% of the total capital
of all broker-dealers registered with the
Commission.748 These statistics
highlight the current baseline for
competition under which the
accountants are operating.
Prior to today’s amendments, the
AICPA established the auditing and
attestation standards to be followed by
the independent public accountants of
broker-dealers (i.e., GAAS). The
AICPA’s auditing standards are revised
and updated from time to time. For
example, the AICPA recently revised
GAAS (including audit standards that
apply to audits of broker-dealer
financial statements), and the revised
standards were generally effective for
fiscal years that ended on or after
December 31, 2012.749 Consequently,
the independent public accountants of
broker-dealers have from time to time
had to familiarize themselves with
updates and revisions to GAAS.
746 Per FINRA’s Web site, there were 4,456 FINRA
member firms at year end 2011. See https://
www.finra.org/Newsroom/Statistics/.
747 See Commission staff, Study on Investment
Advisers and Broker-Dealers, as required by Section
913 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Jan. 2011).
748 This data is based on audited reports filed by
broker-dealers in 2011 and FOCUS Report data.
749 See AICPA, Improving the Clarity of Auditing
Standards, available at https://www.aicpa.org/
InterestAreas/FRC/AuditAttest/Pages/
ImprovingClarityASBStandards.aspx. The AICPA
announced the clarification and convergence
project in July 2008. See https://www.aicpa.org/
InterestAreas/FRC/AuditAttest/
DownloadableDocuments/Clarity/Archive/ASB_
Clarity_%20and_Convergence_(8.5x11).pdf.
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3. SIPC Lawsuits Against Accountants
SIPC was established in 1971. In the
period from 1971 to 2011, SIPC initiated
324 proceedings under SIPA to liquidate
a failed broker-dealer.750 This results in
an average of approximately 8 SIPA
proceedings per year, though 109 of the
324 proceedings were initiated in the
period from 1971 to 1974, which was
the immediate aftermath of the financial
crisis of 1968–1970.751 According to
SIPC staff, SIPC has brought 9 lawsuits
against accountants since 1971, which is
one lawsuit for every 36 SIPA
proceedings.752 The SIPC staff reports
that two of these lawsuits were brought
after the 2001 New York decision
discussed in section II.B.6.iii. of this
release and three lawsuits were brought
in liquidation proceedings that were
active at or about the same time as the
2001 New York decision. The suits
initiated around the time of the 2001
decision and thereafter were brought in
jurisdictions other than New York.
4. Overview of Broker-Dealer Reporting,
Auditing, and Notification
Requirements Before Today’s
Amendments
i. Broker-Dealer Reporting
Before today’s amendments, Rule
17a–5 generally required broker-dealers
to prepare and file a financial report
with the Commission and the brokerdealer’s DEA, as well as a report of a
PCAOB-registered independent public
accountant covering the financial report.
Brokers-dealers also were required to
file concurrently with the audited
financial report a material inadequacy
report prepared by the independent
public accountant.
With regard to the material
inadequacy report, broker-dealers
generally made representations to their
independent public accountants about
their compliance with certain financial
responsibility rules in a representation
letter.753 However, broker-dealers did
not file reports with the Commission or
their DEA containing such
representations. GAAS does not
prescribe specific or standardized
representations to be made by a brokerdealer to its accountant with regard to
an attestation engagement performed
750 See
SIPC, Annual Report 2011, at 6.
See also Commission, Study of Unsafe and
Unsound Practices of Brokers and Dealers: Report
and Recommendations of the Securities and
Exchange Commission (December 1971) (discussing
the financial crisis of 1968–1970). Since its
inception through 2001, SIPC initiated 299
proceedings under SIPA.
752 See discussion above in section II.B.6. of this
release.
753 See, e.g., AICPA Broker-Dealer Audit Guide
app. H (sample representation letter).
751 Id.
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51969
under Rule 17a–5.754 Therefore, brokerdealers’ representations to their
independent public accountant relating
to compliance with certain financial
responsibility rules varied depending on
what was required by the terms of the
individual engagements.
ii. Engagement of the Accountant
As noted above, prior to today’s
amendments, broker-dealers generally
were required to file with the
Commission: (1) A report of an
independent public accountant based
on an audit of the broker-dealer’s
financial statements and supporting
schedules; and (2) a material
inadequacy report prepared by the
accountant, based on, among other
things, a review of a broker-dealer’s
accounting system, internal accounting
control, and procedures for safeguarding
securities. The accountant was required
to be registered with the PCAOB.
However, Rule 17a–5 required that the
audit be performed in accordance with
GAAS, which are issued by the AICPA.
Consequently, the standard setting body
for broker-dealer audits has been the
AICPA (rather than the PCAOB)
notwithstanding the requirement that
broker-dealers be audited by a PCAOBregistered independent public
accountant.755
With regard to the independent public
accountant’s preparation of the material
inadequacy report, Rule 17a–5 required
that the scope of the accountant’s
review be sufficient to provide
‘‘reasonable assurance’’ that any
material inadequacies756 existing at the
754 According to GAAS, auditors ‘‘should
consider obtaining a representation letter’’ in an
examination or review engagement, and ‘‘specific
written representations will depend on the
circumstances of the engagement and the nature of
the subject matter and the criteria.’’ See AICPA, AT
Section 101 at ¶ .60. Further, while the AICPA
Broker-Dealer Audit Guide contains a sample
representation letter, publications such as this
guide ‘‘are not auditing standards’’ but are
‘‘recommendations on the application of the
[auditing standards] in specific circumstances,
including engagements for entities in specialized
industries.’’ See AICPA, AU Section 150, at ¶ .05.
755 See below discussion in section VII.C.1.i. of
this release.
756 Prior to today’s amendments, paragraph (g)(3)
of Rule 17a–5 describes a ‘‘material inadequacy’’ in
a broker-dealer’s accounting system, internal
accounting controls, procedures for safeguarding
securities, and practices and procedures to include
‘‘any condition which has contributed substantially
to or, if appropriate corrective action is not taken,
could reasonably be expected to: (i) inhibit a broker
or dealer from promptly completing securities
transactions or promptly discharging his
responsibilities to customers, other brokers or
dealers or creditors; (ii) result in material financial
loss; (iii) result in material misstatements in the
broker’s or dealer’s financial statements; or (iv)
result in violations of the Commission’s
recordkeeping or financial responsibility rules to an
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date of examination would be disclosed.
As discussed above in section II.D.3. of
this release, the AICPA Broker-Dealer
Audit Guide provided guidance
regarding preparation of the material
inadequacy report. Specifically, AICPA
guidance stated that the material
inadequacy report should address what
the independent public accountant
concluded in its ‘‘study’’ of the
adequacy of the broker-dealer’s
practices and procedures in complying
with the financial responsibility rules in
relation to the definition of material
inadequacy as stated in Rule 17a–5. The
requirement to issue a ‘‘study’’ does not
generally exist outside the context of
broker-dealer audits, however, and,
while auditing standards at one time
referred to the performance of a study,
current auditing standards no longer
contain such references.
If the broker-dealer was exempt from
Rule 15c3–3, Rule 17a–5 required the
independent public accountant to
ascertain that the conditions of the
exemption were being complied with as
of the examination date and that no
facts came to the independent public
accountant’s attention to indicate that
the exemption had not been complied
with during the period since the last
examination.
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iii. Filing of Annual Reports With SIPC
Prior to today’s amendments, brokerdealers that are members of SIPC were
required to file only limited information
with SIPC. This information is elicited
on Form SIPC–6, the ‘‘General
Assessment Payment Form’’ and Form
SIPC–7, the ‘‘Annual General
Assessment Reconciliation.’’ In
addition, for any period during which
the SIPC assessment was not a
minimum assessment as provided for in
section 4(d)(1)(c) of SIPA, paragraph
(e)(4) of Rule 17a–5 generally required
broker-dealers to submit to SIPC a
supplemental report on the status of the
membership of the broker-dealer in
SIPC. The supplemental report, among
other things, had to include a
comparison of the amounts reflected in
the annual financial report the brokerdealer filed with the Commission with
amounts reported on Form SIPC–7.
Form SIPC–6 is filed for the first half of
the fiscal year and Form SIPC–7 is filed
at the end of the fiscal year with a place
to deduct the assessment due and paid
as reflected on Form SIPC–6. These
forms elicit information from a brokerdealer that is a SIPC member about the
extent that could reasonably be expected to result
in the conditions described in [(i) through (iii)
above].’’ 17 CFR 240.17a–5.
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broker-dealer’s sources of revenue
attributable to its securities business.
Prior to today’s amendments, brokerdealers did not file with SIPC the
annual audited financial statements and
accompanying schedules and reports
they filed with the Commission and
their DEA under Rule 17a–5. Therefore,
for example, broker-dealers did not file
their balance sheets, which contain
information concerning their assets,
liabilities, and net worth, or notes to
their financial statements with SIPC.
This information is necessary to
understand the financial conditions of
the broker-dealer and, therefore, in
order for SIPC to determine whether the
SIPC Fund is appropriately sized to the
risks of the broker-dealer industry.
iv. Notification Requirements
Prior to today’s amendments, the
reporting provisions of Rule 17a–5
included references to the term
‘‘material inadequacy.’’ 757 The term
also was used in the Rule 17a–5 and
Rule 17a–11 notification provisions
discussed below.
Rule 17a–5 required that if, during the
course of the audit, the independent
public accountant determined that any
material inadequacies existed, the
independent public accountant was
required to inform the CFO of the
broker-dealer, who was required to give
notice to the Commission and the
broker-dealer’s DEA within 24 hours.
The rule also provided that the brokerdealer must furnish the independent
public accountant with the notice. If the
independent public accountant failed to
receive the notice within the 24-hour
period, or if the accountant disagreed
with the statements contained in the
notice, the accountant was required to
inform the Commission and the DEA
within the next 24 hours and describe
any material inadequacies found to exist
or, if the broker-dealer filed a notice,
detail the aspects of the broker-dealer’s
notice with which the accountant did
not agree.
In addition, Rule 17a–11 required that
when a broker-dealer discovers a
material inadequacy, or is notified by its
independent public accountant under
Rule 17a–5 that a material inadequacy
exists, the broker-dealer must notify the
Commission and its DEA and must
transmit a report stating what the
broker-dealer has done or is doing to
correct the situation.
v. Information Provided to Customers
Prior to today’s amendments, Rule
17a–5 provided that, if the independent
public accountant commented on any
757 See
PO 00000
supra note 756, at 216.
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material inadequacies, the financial
information a broker-dealer was
required to send to customers annually
must include a statement that a copy of
the accountant’s report and comments
was available for customers’ inspection.
In addition, Rule 17a–5 provided a
conditional exemption from the
requirement that a broker-dealer send
paper copies of financial information to
customers, if the broker-dealer was not
required during the prior year to give
notice of a material inadequacy.
vi. Access to Accountants
Prior to today’s amendments, carrying
and clearing broker-dealers were not
required to provide Commission and
DEA examination staff access to their
independent public accountants and
accountant work papers. Such access
would enable Commission and DEA
examiners to obtain information, for
example, regarding areas on which the
accountants focused in order to plan
and conduct risk-based examinations of
carrying and clearing broker-dealers.
vii. Form Custody
Generally, prior to today’s
amendments, broker-dealers were not
required to provide comprehensive or
consolidated information about their
custody practices to the Commission or
their DEA. Some information relating to
a broker-dealer’s custody practices is
included in a broker-dealer’s exchange
membership agreements and clearing
agreements, and in the books and
records of the broker-dealer. In addition,
some information is included on Form
ADV and, therefore, if the broker-dealer
also is a registered investment adviser,
the information is available to the
Commission. Although Commission and
DEA examiners could obtain the
information provided on Form Custody
through detailed examinations of the
broker-dealer’s books and records and
by requesting information from other
sources, the Commission and the
broker-dealer’s DEA did not have a
profile of a broker-dealer’s custodial
activities that could serve as a starting
point to perform more focused
examinations.
C. Costs and Benefits of the Rule
Amendments
This section discusses costs and
benefits of the rule amendments and
new forms for the affected parties
against the economic baseline identified
above, both in terms of each of the
specific changes from the baseline, as
well as in terms of the overall impact.
In considering these costs, benefits, and
impacts, this discussion addresses,
among other things, comments received,
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modifications made to the proposed
amendments and form, and reasonable
alternatives, where applicable.
The costs incurred by a broker-dealer
to comply with the rule amendments
and new form generally will depend on
its size and the complexity of its
business activities. Because the size and
complexity of broker-dealers vary
significantly as indicated in the
economic baseline, their costs could
vary significantly. In some cases, the
Commission is providing estimates of
the average cost per broker-dealer across
all broker-dealers, taking into
consideration the variance in the size of
broker-dealers and the complexity of
their business activities.
1. Broker-Dealer Annual Reporting
Amendments
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i. Changing the Broker-Dealer Audit
Standard Setter From the AICPA to the
PCAOB and the Standards From GAAS
to PCAOB Standards
Today’s amendments require that
audits of broker-dealer financial
statements and schedules be conducted
in accordance with the standards of the
PCAOB, thereby replacing the AICPA as
the standard setter. The amendments
also require that broker-dealers file one
of two new reports—either a compliance
report or an exemption report—and a
report of an independent public
accountant based on an examination of
the compliance report or a review of the
exemption report. This section
discusses the costs and benefits of the
change from the AICPA to the PCAOB
as the standard setter for broker-dealer
audits and the corresponding change
from GAAS to PCAOB standards with
respect to the audit of the financial
statements and schedules. The costs and
benefits of requiring the use of PCAOB
standards with respect to examinations
and reviews of the new compliance
report and exemption report are
discussed separately below in section
VII.C.1.iii. of this economic analysis
regarding the engagement of the
accountant.
The change from the AICPA to the
PCAOB as standard setter for brokerdealer audits and the corresponding
change from GAAS to PCAOB auditing
standards for audits of broker-dealer
financial reports and supporting
schedules provides several benefits. By
requiring that these audits be conducted
in accordance with PCAOB standards,
the amendments align Rule 17a–5 with
statutory provisions. As discussed
above, the Sarbanes-Oxley Act amended
the Exchange Act to require that certain
broker-dealer financial reports filed
with the Commission be audited by an
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accounting firm registered with the
PCAOB. The Dodd-Frank Act, enacted
in July 2010, amended the SarbanesOxley Act to provide the PCAOB with
explicit authority to, among other
things, establish (subject to Commission
approval) auditing and related
attestation, quality control, ethics, and
independence standards for registered
public accounting firms with respect to
their preparation of audit reports to be
included in broker-dealer filings with
the Commission, and the authority to
conduct an inspection program of
registered public accounting firms that
audit broker-dealers.758 However, Rule
17a–5 provided that broker-dealer
audits be performed in accordance with
GAAS; namely, auditing standards
issued by the AICPA.
After today’s amendments, the
PCAOB will be the standard setter for
two types of entities: issuers that are
public companies and broker-dealers.
Given this mandate, the PCAOB can
focus on establishing standards tailored
to these types of entities. For example,
with respect to the audit of the financial
report, the PCAOB has proposed a
standard for auditing supplemental
information accompanying audited
financial statements filed with the
Commission, including supporting
schedules broker-dealers must file with
the Commission and the broker-dealer’s
DEA, such as schedules regarding the
computation of net capital and the
customer reserve requirement and
information related to the brokerdealer’s possession or control of
customer securities.759 In addition, the
PCAOB included the Commission’s
proposal to amend Rule 17a–5 as one of
the factors that led the PCAOB to
‘‘reexamine its requirements regarding
supplemental information.’’ 760
Consequently, the PCAOB has proposed
a standard that would be used for the
supplemental reports to the brokerdealer’s financial report.761 The PCAOB
758 See
Public Law 111–203 § 982.
Proposed Auditing Standard, Auditing
Supplemental Information Accompanying Audited
Financial Statements and Related Amendments to
PCAOB Standards, PCAOB Release No. 2011–05,
PCAOB Rulemaking Docket Matter No. 036, 3 (July
12, 2011) (‘‘PCAOB Proposed Auditing Standard for
Supplemental Information’’). As discussed above,
the PCAOB has also proposed standards for
attestation engagements related to broker-dealer
compliance or exemption reports. See PCAOB
Proposing Release.
760 See PCAOB Proposed Auditing Standard for
Supplemental Information at 2–3.
761 Id. at 2 (‘‘The proposed standard would
benefit investors and other users of financial
statements by updating and enhancing the required
audit procedures when the auditor of the financial
statements is engaged to audit and report on
whether supplemental information accompanying
the financial statements is fairly stated, in all
759 See
PO 00000
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51971
stated that ‘‘[t]he proposed standard
enhances existing PCAOB standards by:
(1) [R]equiring the auditor to perform
certain audit procedures to test and
evaluate the supplemental information,
and (2) [e]stablishing requirements that
promote enhanced coordination
between the work performed on the
supplemental information with work
performed on the financial statement
audit and other engagements, such as a
compliance attestation engagement for
brokers and dealers.’’ 762
The change to the PCAOB as the audit
standard setter for broker-dealers should
facilitate the development of the
PCAOB’s permanent inspection program
as contemplated by the Dodd-Frank Act,
because audits of broker-dealers will be
inspected by the PCAOB in accordance
with its own standards, and not those of
another standard setter, and because of
feedback that can be obtained through
the inspections process regarding gaps
and areas that may need improvement.
Further, the Commission has direct
oversight authority over the PCAOB,
including the ability to approve or
disapprove the PCAOB’s rules.763 This
may help to increase investor
confidence in the independent public
accountants that audit broker-dealers. In
addition, as previously stated, the
Commission has greater confidence in
the quality of audits conducted by an
independent public accountant
registered with, and subject to regular
inspection by, the PCAOB.764
As an alternative approach, one
commenter argued that GAAS should
apply for audits of non-carrying brokerdealers.765 Another commenter stated
that PCAOB standards should apply
only for broker-dealers ‘‘permanently
subject to PCAOB inspection,’’ and that
the Commission should not require that
audits of broker-dealers be performed in
accordance with PCAOB standards for
non-issuer broker-dealers until the
PCAOB determines which non-issuer
material respects, in relation to the financial
statements as a whole.’’).
762 Id. at 4–5.
763 Section 107 of the Sarbanes-Oxley Act states
that no rule of the PCAOB ‘‘shall become effective
without prior approval of the Commission in
accordance with this section, other than as
provided in section 103(a)(3)(B) with respect to
initial or transitional standards.’’ See Public Law
107–204 § 107. This section also states that the
Commission ‘‘shall approve a proposed rule, if it
finds that the rule is consistent with the
requirements of this Act and the securities laws, or
is necessary or appropriate in the public interest or
for the protection of investors’’, and generally
provides that the proposed rule procedures follow
the same rule filing procedure for SROs under
section 19(b) of the Exchange Act. Id.
764 See Custody of Funds or Securities of Clients
by Investment Advisers, 75 FR at 1456.
765 See Citrin Letter.
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broker-dealers will be subject to its
permanent inspection program.766
The Commission has determined that
all audits of broker-dealer financial
statements and supporting schedules
should be performed in accordance with
PCAOB standards for several reasons.
First, allowing the use of more than one
auditing standard would introduce
inconsistencies in audits of brokerdealer financial reports. Second,
allowing the use of non-PCAOB
auditing standards for certain brokerdealer audits would reduce the benefits
discussed above of requiring that all
audits of broker-dealer financial reports
be conducted in accordance with
PCAOB standards. Third, as discussed
in more detail below, the switch from
GAAS to PCAOB standards should not
result in significant incremental costs.
Independent public accountants that
audit issuers are already familiar with
PCAOB audit standards, which should
ease any transition to PCAOB standards
for their audits of broker-dealers.
Although the retention of two standards
could reduce the incremental costs of
switching from GAAS to PCAOB
standards for some independent public
accountants that do not audit issuers, it
would not reduce the incremental costs
for all such independent public
accountants. For example, a
requirement that the financial
statements of one class of broker-dealer
be audited in accordance with GAAS
and the financial statements of another
class of broker-dealer be audited in
accordance with PCAOB standards
would avoid the incremental costs only
for independent public accountants that
limit their audit engagements to the
former class of broker-dealer. These
independent public accountants would
not need to stay current with PCAOB
standards and adopt their procedures to
those standards. However, independent
public accountants that were engaged to
audit broker-dealers in both classes
would need to stay current with both
sets of standards and adopt their
procedures to both sets of standards,
which could increase their incremental
costs. Further, the PCAOB may
determine, subject to Commission
approval, to adopt specific auditing
standards for certain types of brokerdealers (for example, carrying and noncarrying broker-dealers). This could
decrease costs for certain broker-dealer
audits.
The Commission received several
comments on the costs of its proposal to
replace GAAS with PCAOB standards
with respect to audits of broker-dealer
financial reports. Several commenters
766 See
AICPA Letter.
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stated that the Commission did not
address the costs associated with the
change from GAAS to PCAOB
standards.767 One commenter also
stated that the transition to PCAOB
standards from GAAS may require
substantial revisions to broker-dealer
audit programs.768
Current PCAOB standards for audits
of financial information generally
incorporate concepts and requirements
contained within GAAS, thereby
minimizing the potential costs of this
change to independent public
accountants that audit broker-dealers.
For example, in April 2003, the PCAOB
adopted interim auditing standards
consisting of GAAS then in existence, to
the extent not superseded or amended
by the PCAOB.769 The PCAOB’s Web
site lists 50 such standards, including,
for example, a standard relating to
auditing accounting estimates (AU 342)
and a standard relating to auditing fair
value measurements and disclosures
(AU 328).770 The PCAOB has adopted,
and the Commission has approved, 16
PCAOB auditing standards, beginning
with a standard relating to references in
audit reports to PCAOB standards.771
While some independent public
accountants of broker-dealers may incur
one-time implementation costs to
update their broker-dealer audit
programs to reflect PCAOB standards,
the costs should not be significant. As
stated above, most of the PCAOB’s
current standards for audits of financial
reports incorporate concepts and
requirements contained within GAAS.
Thus, the independent public
accountants of broker-dealers already
should be familiar with many of the
PCAOB’s standards. In addition, as
discussed in the economic baseline, the
AICPA from time-to-time updates and
revises its standards. On such an
occurrence, an independent public
accountant would need to take steps to
become familiar with the updates and
revisions and change its broker-dealer
audit program accordingly. This need
for continuing education presumably
already is priced into the audit fees
independent public accountants charge
broker-dealers.
In contrast to the views expressed by
some commenters, the Commission does
e.g., McGladrey Letter; SIFMA Letter.
ABA Letter.
769 See PCAOB Auditing Standards (AS) and
Interim Auditing Standards (AU) (2013), available
at www.pcaobus.org/standards/auditing.
770 Id.
771 See PCAOB Auditing Standard No. 1 (AS No.
1). At least one of these audit standards would not
apply to audits of broker-dealer financial reports.
See PCAOB Auditing Standard No. 5, ‘‘An Audit of
Internal Control Over Financial Reporting that is
Integrated with an Audit of Financial Statements.’’
not expect that a requirement that an
audit of financial statements and
supporting schedules be conducted in
accordance with standards of the
PCAOB instead of with GAAS will
result in substantial changes for brokerdealer audit programs and therefore the
Commission does not anticipate that
this change will result in significant
costs to broker-dealers in the form of
increased audit fees.772
ii. Requirement To File New Reports
Under the amendments, a brokerdealer will need to file one of two new
reports: a compliance report or an
exemption report.773 A carrying brokerdealer (i.e., one that does not claim an
exemption from Rule 15c3–3) must file
the compliance report, and a brokerdealer that claimed an exemption from
Rule 15c3–3 throughout the most recent
fiscal year must file the exemption
report. In the reports, a broker-dealer
must make certain statements and
provide certain information relating to
the financial responsibility rules. In
addition to preparing and filing the
compliance report, a carrying brokerdealer must engage the PCAOBregistered independent public
accountant to prepare a report based on
an examination of certain statements in
the broker-dealer’s compliance
report.774 A broker-dealer that claimed
an exemption from Rule 15c3–3
throughout the most recently ended
fiscal year must engage the PCAOBregistered independent public
accountant to prepare a report based on
a review of certain statements in the
broker-dealer’s exemption report. In
each case, the examination or review
must be conducted in accordance with
PCAOB standards.
a. Compliance Report
Under the amendments, a carrying
broker-dealer must prepare and file with
the Commission a new compliance
report each year, along with a report
prepared by a PCAOB-registered
independent public accountant based
on an examination of certain statements
made in the compliance report in
accordance with PCAOB standards.775
The compliance report must contain
statements as to whether: (1) The
broker-dealer has established and
767 See,
768 See
PO 00000
Frm 00064
Fmt 4701
Sfmt 4700
772 As discussed in section V. of this release, the
Commission has delayed the compliance date for
this requirement to provide sufficient time for
broker-dealers and their accountants to prepare to
comply with the new requirement.
773 See discussion above in sections II.B.1., II.B.3.,
and II.B.4. of this release.
774 See paragraphs (f)(1) and (g)(2)(i) of Rule 17a–
5.
775 See discussion above in sections II.B.1., II.B.3.,
and II.D.3. of this release.
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maintained Internal Control Over
Compliance; (2) the Internal Control
Over Compliance of the broker-dealer
was effective during the most recent
fiscal year; (3) the Internal Control Over
Compliance of the broker-dealer was
effective as of the end of the most recent
fiscal year; (4) the broker-dealer was in
compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3 as of the
end of the most recent fiscal year; and
(5) the information the broker-dealer
used to state whether it was in
compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3 was
derived from the books and records of
the broker-dealer. In addition, if
applicable, the compliance report must
contain a description of: (1) Each
identified material weakness in the
Internal Control Over Compliance
during the most recent fiscal year,
including those that were identified as
of the end of the fiscal year; and (2) any
instance of non-compliance with Rule
15c3–1 or paragraph (e) of Rule 15c3–
3 as of the end of the most recent fiscal
year.
The compliance report requirements
provide a number of benefits. For
example, specifying and standardizing
the statements required in the
compliance report should promote
consistent compliance with Rule 17a–5
and should ensure that the Commission
receives information relating to aspects
of a carrying broker-dealer’s compliance
with the financial responsibility rules
that are of particular concern. Although,
as discussed above in section II.D.3. of
this release, current auditing standards
require that independent public
accountants obtain written
representations from management as
part of the audits of financial statements
and attestation engagements, GAAS
only provide examples of management
representations and do not mandate that
specific management representations be
made. By clearly specifying and
standardizing the statements, the
compliance report should increase
consistency with respect to the matters
examined by the independent public
accountants as part of the examination
of the compliance report.
The specification and standardization
of the statements also should facilitate
Commission and DEA oversight of
broker-dealer compliance with the
financial responsibility rules to the
benefit of broker-dealer customers, by
helping the Commission and DEAs to
more quickly identify broker-dealers
with potential problems. Moreover, as
adopted, the final rule requires a brokerdealer’s compliance report to include
information regarding whether the
broker-dealer’s internal control was
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effective as of the end of the fiscal year,
in addition to information regarding
whether there were material weaknesses
in the Internal Control Over Compliance
during the fiscal year. This will provide
the Commission and the DEA with
information on whether the brokerdealer has taken action by the end of the
fiscal year to cure any material
weaknesses in the Internal Control Over
Compliance that existed during the
fiscal year.
Requiring the compliance report to be
filed with the Commission and the
broker-dealer’s DEA also should
increase broker-dealers’ focus on
ensuring the accuracy of the statements
being made and enhance compliance
with the financial responsibility rules
given the penalties for false filings. For
example, filers are subject to penalties
for willfully making false statements in
any application, report, or document
filed with the Commission.776
One commenter stated that
incremental benefits of having the
assertion in the compliance report with
respect to internal controls pertain to
the whole year rather than the fiscal
year end does not justify the costs.777 In
response, the Commission notes that
key requirements in the financial
responsibility rules must be complied
with on an on-going basis throughout
the year. Therefore, it is critical to have
internal controls over compliance with
these rules that are effective throughout
the year rather than just at fiscal year
end. Therefore, the Commission
believes that there are benefits to having
a carrying broker-dealer state that its
Internal Control Over Compliance was
effective throughout the year.
Broker-dealers will incur costs
associated with preparing the
compliance report. The level of effort
required by carrying broker-dealers to
prepare a compliance report will
depend on the nature of the activities of
the broker-dealer. For example, the
controls necessary for a carrying brokerdealer that engages in limited custodial
activities generally should be less
complex than the controls necessary for
a carrying broker-dealer that engages in
more extensive custodial activities.
Therefore, a carrying broker-dealer with
limited custodial activities should have
to expend less effort to make its
statements in the compliance report
relating to the effectiveness of its
Internal Control Over Compliance. To
the extent that the amount of custodial
activity is related to the size of a brokerdealer, the cost of preparing the
776 See,
777 See
PO 00000
e.g., 15 U.S.C. 78ff(a).
E&Y Letter.
Frm 00065
Fmt 4701
Sfmt 4700
51973
compliance report should be lower for
smaller carrying broker-dealers.
The Commission estimated in the
proposing release that, on average,
carrying broker-dealers would spend
approximately 60 hours each year to
prepare the proposed compliance
report.778 One commenter stated that
the proposal did not ‘‘address the
additional costs broker-dealers would
incur in preparing Compliance
Reports.’’ 779 However, the commenter
did not comment on the estimated hour
burden or provide specific data and
analysis on the additional costs that
broker-dealers would incur in preparing
compliance reports. Another commenter
stated that the proposed estimate of 60
hours ‘‘is not an accurate estimate of the
time burden to complete the
Compliance Report’’ and that the
burdens in the proposing release are
understated.780 This commenter,
however, did not provide a quantified
alternative estimate of the costs or
specific data to support its statement.
The Commission is retaining the 60hour estimate for the reasons discussed
below. The final rules contain two
changes from the proposal that could
result in lower costs than if the rules
had been adopted as proposed: (1)
Elimination of the concepts of ‘‘material
non-compliance’’ and ‘‘compliance in
all material respects’’ with Rule 15c3–1
and 15c3–3 for the purposes of reporting
in the compliance report; and (2) a
narrowing of these statements and
description requirements from
compliance with all of the financial
responsibility rules to compliance with
Rule 15c3–1 and paragraph (e) of Rule
15c3–3.
As previously discussed, many
commenters raised concerns about how
firms would determine whether an
instance of non-compliance constitutes
material non-compliance.781
Commenters urged the Commission to
provide guidance with additional
specific examples or quantitative and
qualitative factors to be considered
when determining whether noncompliance was material,782 or
proposing alternate definitions or
examples of non-compliance that
should not be regarded as material.783
Under the rules as adopted, brokerdealers will not be required to conduct
778 See
Broker-Dealer Reports, 76 FR 37596.
SIFMA Letter.
780 See Van Kampen/Invesco Letter.
781 See ABA Letter; CAI Letter; CAQ Letter;
Deloitte Letter; E&Y Letter; Grant Thornton Letter;
KPMG Letter; McGladrey Letter; PWC Letter; SIFMA
Letter; Van Kampen/Invesco Letter.
782 See ABA Letter; CAQ Letter; E&Y Letter; KPMG
Letter; McGladrey Letter; PWC Letter.
783 See SIFMA Letter.
779 See
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a separate evaluation of materiality
when determining instances of noncompliance that must be reported. This
should reduce the likelihood that
inconsistent approaches be taken both
among broker-dealers and between
broker-dealers and their independent
public accountants.
The ‘‘material non-compliance’’ and
‘‘compliance in all material respects’’
concepts were designed to limit the
types of instances of non-compliance
that would need to be identified in the
report. To retain a limiting principle,
the final rule focuses on provisions that
trigger notification requirements when
they are not complied with, namely,
Rule 15c3–1 and the customer reserve
requirement in paragraph (e) of Rule
15c3–3.784 Any instances of noncompliance with these requirements as
of the fiscal year end must be described
in the compliance report. As stated in
the proposing release, failing to
maintain the required minimum amount
of net capital under Rule 15c3–1 or
failing to maintain the minimum
deposit requirement in a special reserve
bank account under Rule 15c3–3 would
have been instances of material noncompliance under the proposed rule.785
Accordingly, under the proposal, a
broker-dealer would have been required
to describe all instances of noncompliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3. Under the
proposal, a broker-dealer also would
have been required to describe instances
of material non-compliance with Rule
17a–13 and the Account Statement
Rules. The final rule is narrower in that
a broker-dealer only is required to
describe instances of non-compliance
with Rule 15c3–1 and paragraph (e) of
Rule 15c3–3. While the final rules
increase costs relative to the baseline,
they should result in modestly lower
costs to broker-dealers relative to the
proposal.
The final rule also retains the
proposed requirement that the carrying
broker-dealer provide a description of
each identified material weakness in the
internal control of the broker-dealer
over compliance with the financial
responsibility rules, but, in conformity
with other modifications to the
proposal, the final rule specifies that the
material weaknesses include those
identified during the most recent fiscal
year as well as those that were
identified as of the end of the fiscal
year.786 The Commission believes that
784 See 17 CFR 240.15c3–1(a)(6)(iv)(B), (a)(6)(v),
(a)(7)(ii), (a)(7)(iii), (c)(2)(x)(B)(1), (c)(2)(x)(F)(3); 17
CFR 240.17a –11(b)–(c); 17 CFR 240.15c3–3(i).
785 See Broker-Dealer Reports, 76 FR at 37577.
786 See 17 CFR 240.17a–5(d)(3)(i)(B).
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the modifications to the final rule
discussed above may modestly reduce
the hour burden of the final rule as
compared to the hour burden that
would have resulted from the proposed
rule; namely, because a broker-dealer
will not need to evaluate whether
instances of non-compliance with the
financial responsibility rules are
material and will only need to report
instances of non-compliance with Rule
15c3–1 and paragraph (e) of Rule 15c3–
3. While these modifications will result
in additional costs to broker-dealers
over the baseline, they are not expected
to increase costs over those estimated
for the proposed rule. This is because
the proposed statement as to whether
the broker-dealer’s Internal Control Over
Compliance was effective during the
most recent fiscal year, and the related
statement about material weakness,
would also cover the fiscal year end. As
noted above, the modification to require
two statements (one covering the fiscal
year and one covering the fiscal year
end) was prompted by commenter
suggestions that broker-dealers be
permitted to report the remediation of a
material weakness, or whether a
material weakness still exists, at the end
of the fiscal year. These changes will
provide information to the Commission
and DEAs as to whether material
weaknesses during the year have been
remediated as of the fiscal year end.
They also afford the broker-dealer the
opportunity to state in the report that a
material weakness has been remediated,
if applicable.
The changes discussed above, in some
cases, may result in a modest reduction
in burden relative to the proposal.
However, while some commenters
suggested that the proposing release
underestimated the burden, the
Commission is not changing its estimate
of the time required for a broker-dealer
to prepare the compliance report. The
Commission notes that, while
commenters questioned the estimate,
they did not provide data that would
enable the Commission to revise its
estimate.
The Commission, however, is
updating its estimates of the number of
broker-dealers that would be required to
file the compliance report, which affects
the cost estimates. The Commission
now estimates that there are
approximately 292 carrying brokerdealers. Therefore, the Commission
estimates that the time required for all
292 carrying broker-dealers to prepare
the report is approximately 17,520
PO 00000
Frm 00066
Fmt 4701
Sfmt 4700
hours per year.787 Further, the
Commission estimates that the total
cost 788 associated with this requirement
is approximately $5.6 million per
year.789
b. Exemption Report
Broker-dealers that claim an
exemption from Rule 15c3–3 are
required to file an exemption report and
a report of the independent public
accountant based on a review of the
exemption report. The exemption report
must contain the following statements
made to the best knowledge and belief
of the broker-dealer: (1) A statement that
identifies the provisions in paragraph
(k) of Rule 15c3–3 under which the
broker-dealer claimed an exemption
from Rule 15c3–3; (2) a statement the
broker-dealer met the identified
exemption provisions in paragraph (k)
of Rule 15c3–3 throughout the most
recent fiscal year without exception or
that it met the identified exemption
provisions in paragraph (k) of Rule
15c3–3 throughout the most recent
fiscal year except as described in the
exemption report; and (3) if applicable,
a statement that identifies each
exception during the most recent fiscal
year in meeting the identified
provisions in paragraph (k) of Rule
15c3–3 and that briefly describes the
787 See discussion above in section VI.D.1.ii. of
this release. 60 hours × 292 carrying broker-dealers
= 17,520 hours per year.
788 For purposes of this economic analysis, salary
data is from the Securities Industry and Financial
Markets Association (‘‘SIFMA’’) Report on
Management and Professional Earnings in the
Securities Industry 2011 (‘‘SIFMA Report on
Management and Professional Earnings in the
Securities Industry’’), which provides base salary
and bonus information for middle-management and
professional positions within the securities
industry. The salary costs derived from the report
and referenced in this cost benefit section are
modified to account for an 1800-hour work year and
multiplied by 5.35 to account for bonuses, firm size,
employee benefits, and overhead.
789 See discussion above in section VI.D.1.ii. of
this release. Based on staff experience, the
Commission believes that a carrying broker-dealer
likely would have a Compliance Manager gather
information necessary to validate the statements to
be provided and that it would take the Compliance
Manager approximately 45 hours to perform this
task. In addition, the Commission believes that a
carrying broker-dealer likely would have a Chief
Compliance Officer review the information and
make the attestation and that it would take the
Chief Compliance Officer approximately 15 hours
per year to perform this task. According to the
SIFMA Report on Management and Professional
Earnings in the Securities Industry, as modified by
Commission staff to account for an 1,800-hour
work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead,
the hourly cost of a Compliance Manager is
approximately $279/hour, and the hourly cost of a
Chief Compliance Officer is approximately $433/
hour. 292 carrying broker-dealers × 45 hours × $279
= $3,666,060. 292 carrying broker-dealers × 15
hours × $433 = $1,896,540. $3,666,060 + $1,896,540
= $5,562,600 per year.
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nature of each exception and the
approximate date(s) on which the
exception existed.
The preparation of exemption reports
by broker-dealers that claim an
exemption from Rule 15c3–3 throughout
the most recent fiscal year, as well as
reviews of certain statements in the
exemption reports by independent
public accountants, should strengthen
and facilitate consistent compliance
with the Commission’s financial
responsibility rules, for many of the
same reasons identified above with
respect to the compliance report.
Among other things, these reports
should enhance compliance with the
exemption provisions in Rule 15c3–3,
thereby providing better protection of
customer assets. This increased focus is
enhanced further by requiring the direct
filing of the exemption report with the
Commission and the broker-dealer’s
DEA because of the potential penalties
for false statements. In addition, the
Commission and the broker-dealer’s
DEA will benefit from the information
provided in the exemption report in
conducting their supervisory oversight
of the broker-dealer.
The Commission considered an
alternative suggested by one commenter
to replace the exemption report with a
box to check on the FOCUS Report.790
After careful consideration of this
alternative, the Commission determined
that it is not an appropriate alternative
to the exemption report. As discussed
above in section II.B.4.iii. of this release,
a broker-dealer claiming an exemption
from Rule 15c3–3 already is required to
indicate the basis for the exemption on
its FOCUS Report.791 Second, the
exemption report requires the brokerdealer to make certain statements that
the independent public accountant must
review. Thus, the exemption report will
provide a standardized statement across
all broker-dealers claiming an
exemption from Rule 15c3–3 for the
independent public accountant to
review. Third, the exemption report will
provide the Commission and the brokerdealer’s DEA with more information
than currently is reported by noncarrying broker-dealer’s in the FOCUS
Report. Specifically, it requires the
broker-dealer to, among other things,
state either that it met the identified
exemption provisions in paragraph (k)
throughout the most recent fiscal year
without exception or that it met the
identified exemption provisions
throughout the most recent fiscal year
except as described in the report. This
will provide the Commission and the
790 See
791 See
Angel Letter.
Item 24 of Part IIa of the FOCUS Report.
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broker-dealer’s DEA with information as
to whether a broker-dealer is meeting
the exemption provisions of paragraph
(k) of Rule 15c3–3 (not simply that the
broker-dealer is claiming the exemption
as is reported in the FOCUS Report).
The Commission expects that noncarrying broker-dealers generally track
exceptions as part of monitoring
compliance with the exemption
provisions in paragraph (k) of Rule
15c3–3. Fourth, requiring that the
exemption report be filed with the
Commission should increase brokerdealers’ focus on the statements being
made, facilitating consistent compliance
with the exemption provisions in Rule
15c3–3, and therefore, providing better
protection of customer assets. Further,
employing a ‘‘check the box’’ alternative
would not substantially reduce
compliance costs because the brokerdealer would need to take steps to
ascertain that it has a valid basis for
claiming the exemption, whether or not
these steps result in an exemption
report or ‘‘check the box.’’
The Commission estimated that it
would take a non-carrying broker-dealer
approximately five hours to prepare and
file the proposed exemption report.792
The Commission did not receive
comments specifically addressing this
estimate. However, because the rule was
modified from the proposal to also
require the identification of exceptions
to the exemption provisions, the
Commission is increasing the estimate
to seven hours.793 The Commission now
estimates that there are approximately
4,417 non-carrying broker-dealers that
must file exemption reports. Therefore,
the Commission estimates that the
annual reporting burden for all noncarrying broker-dealers to prepare and
file the exemption report is
approximately 30,919 hours per year.794
The Commission estimates that the total
industry-wide cost to prepare the
exemption report is approximately $9.3
million per year.795
792 See
Broker-Dealer Reports, 76 FR at 37596.
discussion above in section VI.D.1.iii. of
this release.
794 See discussion above in section VI.D.1.iii. of
this release. 7 hours × 4,417 non-carrying brokerdealers = 30,919 hours per year. See the discussion
below regarding the external costs associated with
obtaining the accountant’s report on the exemption
report.
795 See discussion above in section VI.D.1.iii. of
this release. Based on staff experience, a noncarrying broker-dealer likely would have a
Compliance Manager gather information necessary
to validate the information to be provided in the
exemption report, and it would take the
Compliance Manager approximately six hours to
perform this task. In addition, a non-carrying
broker-dealer likely would have a Chief Compliance
Officer review the information and make the
attestation, and it would take the Chief Compliance
793 See
PO 00000
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iii. Engagement of the Accountant
As discussed above, the amendments
to Rule 17a–5 eliminate the requirement
that the broker-dealer’s independent
public accountant prepare, and the
broker-dealer file with the Commission
and its DEA concurrently with its
annual audited financial statements, a
material inadequacy report, based on,
among other things, a review of a
broker-dealer’s accounting system,
internal accounting control, and
procedures for safeguarding securities.
The amendments replace this
requirement with a requirement, among
other things, that the broker-dealer file
with its annual reports a report prepared
by an accountant covering either the
broker-dealer’s compliance report or
exemption report, as applicable. The
accountant engaged by the broker-dealer
must, as part of the engagement,
undertake to prepare its reports based
on an examination of certain statements
in the compliance report or a review of
certain statements in the exemption
report, as applicable, in accordance with
PCAOB standards.
With regard to the independent public
accountant’s preparation of the material
inadequacy report, Rule 17a–5 required
that the scope of the accountant’s
review be sufficient to provide
‘‘reasonable assurance’’ that any
material inadequacies existing at the
date of examination would be disclosed.
If the broker-dealer was exempt from
Rule 15c3–3, Rule 17a–5 provided that
the accountant must ascertain that the
conditions of the exemption were being
complied with as of the examination
date and that no facts came to the
accountant’s attention to indicate that
the conditions of the exemption had not
been complied with since the last
examination. As discussed above,
AICPA guidance provided that the
material inadequacy report should
address what the independent public
accountant concluded in its ‘‘study’’ of
the adequacy of the broker-dealer’s
practices and procedures in complying
with the financial responsibility rules in
Officer approximately one hour to perform this task.
According to the SIFMA Report on Management
and Professional Earnings in the Securities
Industry, as modified by Commission staff to
account for an 1,800-hour work-year and multiplied
by 5.35 to account for bonuses, firm size, employee
benefits and overhead, the hourly cost of a
Compliance Manager is approximately $279/hour,
and the hourly cost of a Chief Compliance Officer
is approximately $433/hour. 4,417 non-carrying
broker-dealers × 6 hours × $279 = $7,394,058 per
year. 4,417 non-carrying broker-dealers × 1 hour ×
$433 = $1,912,561 per year. $7,394,058 +
$1,912,561 = $9,306,619 per year.
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relation to the definition of material
inadequacy as stated in Rule 17a–5.796
However, in the PCAOB’s first report
on the progress of its interim inspection
program of broker-dealer audits, the
PCAOB stated that as to 21 of the 23
audits inspected, the accountant ‘‘failed
to perform sufficient audit procedures to
obtain reasonable assurance that any
material inadequacies found to exist
since the date of the last examination
. . . would have been disclosed in the
accountant’s supplement report.’’ 797
Further, for all of the 14 audits of
broker-dealers that claimed an
exemption from Rule 15c3–3, the
PCAOB stated that the accountant ‘‘did
not perform sufficient procedures to
ascertain that the broker or dealer
complied with the conditions of the
exemption.’’ 798 The deficiencies noted
in the PCAOB’s report on the progress
of the interim inspection program
provide further support for the
amendments that the Commission is
adopting today to establish the
foundation for the PCAOB’s
development of standards that are
tailored to Rule 17a–5, and to strengthen
and facilitate consistent compliance
with broker-dealer audit and reporting
requirements.
Generally, the engagement of
accountant amendments should result
in higher levels of compliance with the
Commission’s financial responsibility
rules by increasing the focus of carrying
broker-dealers and their independent
public accountants on specific
statements made in the compliance
report relating to the broker-dealer’s
compliance, and internal control over
compliance, with the financial
responsibility rules and increasing the
focus of non-carrying broker-dealers and
their independent public accountants
on whether the broker-dealer meets the
exemption provisions in paragraph (k)
of Rule 15c3–3. These amendments also
clarify the scope and the standards that
apply to broker-dealer audits and
conform language in the rule with
terminology in existing audit literature,
which should reduce inconsistencies in
broker-dealer compliance with Rule
17a–5. The replacement of the material
inadequacy report with the report based
on an examination of the compliance
report or review of the exemption report
facilitates the Commission’s objective to
provide clear and consistent
terminology focused separately on
compliance with the financial
responsibility rules and internal control
796 See AICPA Broker-Dealer Audit Guide at
¶ 3.77.
797 See PCAOB Inspection Report at iii.
798 Id.
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over compliance with the financial
responsibility rules.
With regard to the examination of the
compliance report, the amendments are
intended to encourage greater focus by
the independent public accountant on
Internal Control Over Compliance,
including, in particular, broker-dealer
custody practices. By specifying the
statements that must be made by a
broker-dealer to the Commission, and
hence, examined by the auditor, the
compliance report should provide
clarity and facilitate consistent
compliance with Rule 17a–5 by
independent public accountants.
Additionally, the focus of independent
public accountants on internal control
over the custody practices of brokerdealers should better identify brokerdealers that have weak internal controls
for safeguarding investor securities and
cash. Similarly, with regard to the
review of the exemption report, the
amendments encourage greater focus by
the accountant on whether the brokerdealer has appropriately claimed an
exemption from Rule 15c3–3 by, among
other things, reviewing whether the
broker-dealer’s statements in the
exemption report as to meeting the
exemption provisions without or with
exceptions, and, if applicable,
identifying exceptions to meeting those
provisions, were fairly stated.799 As
stated above, the terminology in Rule
17a–5 with regard to the material
inadequacy report was outdated and
inconsistent with current audit
practices.
The PCAOB stated that its proposed
attestation standards for examining
compliance reports and reviewing
exemption reports were ‘‘tailored’’ to
the proposed amendments to Rule 17a–
5.800 These standards, if adopted, are
expected to establish a single and
broker-dealer-specific approach to
examining compliance reports and
reviewing exemption reports and are
expected to enable the accountant to
scale the engagement based on the
broker-dealer’s size and complexity.
Based on its estimates of the costs
associated with the cost of an internal
control report under Rule 206(4)–2, the
Commission estimated that the external
cost to a carrying broker-dealer of
obtaining the independent public
accountant’s report based on an
examination of the proposed
799 As stated above, a review engagement is
designed to provide a moderate level of assurance,
and the accountant’s conclusion could state, for
example, that no information came to the
accountant’s attention that indicates that the
exemption report is not fairly stated in all material
respects.
800 See PCAOB Proposing Release at 5.
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compliance report would be an average
incremental cost of approximately
$150,000 per carrying broker-dealer per
year.801 Based on staff experience,
including communications with brokerdealers, broker-dealer independent
public accountants, and independent
public accountant industry groups, the
Commission estimated that the external
cost to a non-carrying broker-dealer of
obtaining the independent public
accountant’s report based on a review of
the proposed exemption report would
cost an average of approximately $3,000
per non-carrying broker-dealer per
year.802 Before today’s amendments,
independent public accountants of
broker-dealers were required to prepare
a material inadequacy report. As that
report is no longer required, the costs
associated with engaging the
independent public accountant to
prepare a material inadequacy report
have been eliminated and replaced by
the costs associated with engaging the
independent public accountant to
prepare a report covering the
compliance report or the exemption
report. Therefore, the incremental cost
of today’s amendments related to the
engagement of the independent public
accountant is the amount that the cost
exceeds the cost of engaging the
independent public accountant to
prepare the material inadequacy report.
However, the Commission has not
previously estimated the average cost of
preparing the material inadequacy
report. Consequently, the Commission is
retaining the cost estimates set forth in
the proposing release, while recognizing
that costs could be lower as a result of
cost savings attributable to the
elimination of the material inadequacy
report requirements.
The Commission received various
comments regarding the engagement of
accountant provisions as they relate to
examining or reviewing the proposed
compliance reports and exemption
reports, respectively. One commenter
stated that the Commission
underestimated the cost of examining
the compliance report and that the
Commission may need to consider the
801 See Broker-Dealer Reports, 76 FR at 37599.
See also discussion above in section VI.D.1.vii.b. of
this release.
802 See Broker-Dealer Reports, 76 FR at 37600.
The Commission estimated that the average cost of
an audit of a non-carrying broker-dealer’s financial
report was approximately $30,000 per year, based
on a weighted average of estimates of that cost for
broker-dealers with varying levels of net income.
The Commission further estimated that the
additional cost for a review of the exemption report
would be an average of approximately $3,000 per
non-carrying broker-dealer per year. Id. See also
discussion above in section VI.D.1.vii.c. of this
release.
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PCAOB’s proposed rules before it can
reasonably estimate this cost.803
Another commenter stated that the
proposed amendments have ‘‘the
potential to double the total current
audit fees and have a material impact’’
on firms.804 A third commenter stated
that the economic analysis was
‘‘inconclusive’’ because the PCAOB has
not yet established auditing and
attestation standards for brokerdealers.805 The commenters, however,
did not provide quantified alternative
cost estimates.
The Commission acknowledges that
the total costs associated with these
requirements will depend on the final
PCAOB standards for attestation
engagements to examine compliance
reports or review exemption reports.
However, as the PCAOB’s proposed
standards were tailored to the proposed
amendments, nothing in those standards
causes the Commission to change its
estimates of the costs associated with
these requirements, or to question that
the benefits will justify the costs.
Before today’s amendments, Rule
17a–5 required the independent public
accountant to, among other things,
review the accounting system, internal
accounting control, and procedures for
safeguarding securities of the brokerdealer, including appropriate tests, for
the period since the prior examination
date. The scope of the independent
public accountant’s review was required
to be sufficient to provide reasonable
assurance that any material
inadequacies existing at the date of the
auditor examination would be
disclosed. Similarly, an examination of
a compliance report performed under
the PCAOB’s attestation standard for
examination engagements would require
that the auditor obtain reasonable
assurance to express an opinion on
whether the broker-dealer’s statements
in the compliance report are fairly
stated, in all material respects.806
Moreover, before today’s
amendments, if a broker-dealer was
exempt from Rule15c3–3, Rule 17a–5
required the independent public
accountant to ‘‘ascertain that the
conditions of the exemption were being
803 See
ABA Letter.
Van Kampen/Invesco Letter.
805 See CAI Letter.
806 See PCAOB Proposing Release at 5. An
examination engagement is designed to provide a
high level of assurance. See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ¶ .54. In
this case, the accountant’s conclusion will be
expressed in the form of an opinion. For example,
the accountant’s conclusion based on an
examination of an assertion could state that in the
accountant’s opinion, [the assertion] is fairly stated
in all material respects. See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ¶ .84.
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804 See
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complied with as of the examination
date and that no facts came to [the
independent public accountant’s]
attention to indicate that the exemption
had not been complied with during the
period since [the independent public
accountant’s] last examination.’’ 807 The
PCAOB’s proposed review standard for
the exemption report would require that
the independent public accountant
make inquiries and perform other
procedures that are commensurate with
the auditor’s responsibility to obtain
moderate assurance that the brokerdealer meets the identified conditions
for an exemption from Rule 15c3–3.808
These procedures would include
evaluating relevant evidence obtained
from the audit of the financial
statements and supporting schedules
and are designed to enable the auditor
to scale the review engagement based on
the broker-dealer’s size and
complexity.809
The compliance report as adopted
includes an additional statement
(relative to the proposal) as to whether
the broker-dealer’s Internal Control Over
Compliance was effective as of the end
of the most recent fiscal year. Therefore,
costs of compliance with the final rules
may be higher than costs of compliance
with the proposed rules to the extent
Internal Control Over Compliance has
changed near or as of the fiscal year end.
However, this increased cost is not
expected to be significant, since the
procedures needed to opine on these
matters as of the fiscal year end should
not be materially different from the
procedures employed to opine as to the
effectiveness of internal control over the
course of the fiscal year.
As proposed, the broker-dealer would
have been required to assert whether it
was in compliance, in all material
respects, with all of the financial
responsibility rules as of its fiscal year
end. As adopted, the broker-dealer must
assert whether it is in compliance with
Rule 15c3–1 and paragraph (e) of Rule
15c3–3 (i.e., a narrower range of rule
compliance than proposed). This
modification of the broker-dealer’s
assertion could result in lower costs for
accountants’ reports on the compliance
report as compared to the proposal as
the scope of the matters to be covered
by accountants’ examinations will be
narrower.
Although these modifications could
modestly lower costs associated with
the accountant’s report covering the
compliance report as compared to the
proposal, the Commission is not
807 See
17 CFR 240.17a–5(g)(2).
PCAOB Proposing Release at 8.
809 Id. at 9.
808 See
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changing its estimate of costs associated
with accountants’ reports covering
compliance reports and exemption
reports. Based on updated data, the
Commission now estimates that there
are approximately 292 carrying brokerdealers. The Commission therefore
estimates that the industry-wide annual
average incremental external reporting
cost of accountants’ reports based on
examinations of compliance reports is
approximately $44 million per year
($150,000 times 292 carrying brokerdealers = $43,800,000).810 Based on
updated data, the Commission now
estimates that there are approximately
4,417 non-carrying broker-dealers. The
Commission therefore estimates that the
total industry-wide annual reporting
cost of accountant’s reports based on
reviews of exemption reports is
approximately $13.3 million per year
(4,417 non-carrying broker-dealers times
$3,000 = $13,251,000).811 The
Commission therefore estimates that the
total industry-wide incremental external
annual reporting cost to broker-dealers
associated with the accountants’ reports
covering the compliance report and
exemption report is approximately
$57.3 million per year.
Finally, one commenter suggested
that the Commission use an ‘‘agreedupon procedures’’ engagement for the
exemption report.812 This alternative
was considered. The final rule,
however, requires a review engagement
as proposed. Under an ‘‘agreed-upon
procedures’’ engagement, the
independent public accountant is
engaged by a client to issue a report of
findings based on specific procedures
performed on subject matter that the
specified parties believe are
appropriate.813 Additionally, in an
‘‘agreed-upon procedures’’ engagement,
the independent public accountant does
not perform an examination or a review,
and does not provide an opinion or
negative assurance. Thus, no conclusion
would be rendered as to the brokerdealer’s statements in the exemption
report.
Another commenter stated that the
benefit of receiving an audit report
covering the exemption report would
not justify the cost 814 and, similarly, a
second commenter did not see a benefit
from the auditor attestation of the
810 See discussion above in section VI.D.1.vii.b. of
this release.
811 See discussion above in section VI.D.1.vii.c. of
this release.
812 See E&Y Letter.
813 See PCAOB Interim Attestation Standard, AT
Section 201 at ¶ .03.
814 See Citrin Letter.
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exemption report.815 As noted above,
before today’s amendments, if a brokerdealer was exempt from Rule15c3–3,
Rule 17a–5 required the independent
public accountant to ‘‘ascertain that the
conditions of the exemption were being
complied with as of the examination
date and that no facts came to [the
independent public accountant’s]
attention to indicate that the exemption
had not been complied with during the
period since [the independent public
accountant’s] last examination.’’ 816
Consequently, the current rule requires
the independent public accountant to
reach a conclusion with respect to a
broker-dealer’s claimed exemption from
Rule 15c3–3.
The Commission believes the rule
should continue to require a conclusion
from the independent public accountant
on the broker-dealer’s claimed
exemption from Rule 15c3–3 because of
the importance of safeguarding
customer securities and cash. While the
Commission anticipates there will be
costs related to the audit of the
exemption report, the Commission does
not believe it would be appropriate to
use a lower standard (i.e., the agreedupon procedures standard) or have no
requirement for the independent public
accountant to perform any work with
respect to the exemption report.
iv. Filing of Annual Reports With SIPC
The amendments to Rule 17a–5
require broker-dealers that are SIPC
members to file their annual reports
with SIPC. SIPC plays an important role
in the securities markets by serving as
a backstop to protect customers of a
failed broker-dealer that cannot
promptly return customer securities and
funds. In this capacity, SIPC has a
legitimate interest in receiving the
annual reports of its broker-dealer
members to assist it with its
maintenance of the SIPC Fund and to
monitor trends in the broker-dealer
industry. For example, SIPC presently
obtains revenue information from
broker-dealers, through Form SIPC–7, to
determine how best to structure brokerdealer assessments to maintain the SIPC
Fund at an appropriate level. However,
the information collected in the form is
limited and may not assist SIPC in
assessing whether the SIPC Fund is
appropriately sized to the risks of a large
broker-dealer failure. The annual reports
contain much more detailed information
about the assets, liabilities, income, net
capital, and Rule 15c3–3 customer
reserve requirements of broker-dealers,
and also include, for carrying broker-
817 See SIPC v. BDO Seidman, LLP, 746 NE.2d
1042 (N.Y. 2001); aff’d, 245 F.3d 174 (2d Cir. 2001).
818 See Broker-Dealer Reports, 76 FR at 37596.
815 See
Angel Letter.
816 See 17 CFR 240.17a–5(g)(2).
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dealers, a compliance report containing
information about the broker-dealer’s
compliance with, and controls over
compliance with, the broker-dealer
financial responsibility rules. The
annual reports also generally include
the independent public accountant’s
reports covering the financial report and
compliance report or exemption report,
as applicable, prepared by the brokerdealer. This information also will assist
SIPC in monitoring the financial
strength of broker-dealers and, therefore,
in assessing the adequacy of the SIPC
Fund.
In addition, by receiving the annual
reports, SIPC may be able to overcome
a potential legal hurdle to pursuing
claims against a broker-dealer’s
accountant where the accountant’s
failure to adhere to professional
standards in auditing a broker-dealer
causes a loss to the SIPC Fund. As
discussed in section II.B.6. of this
release, SIPC has sought to recover
money damages from the broker-dealer’s
independent public accountant based
on an alleged failure to comply with
auditing standards, but at least one
court has held under New York law that
SIPC could not maintain a claim
because it was not a recipient of the
annual audit filing and could not have
relied on it.817
SIPC’s improved ability to maintain
the SIPC Fund will benefit investors.
First, if the SIPC Fund is appropriately
sized, customers of a failed brokerdealer in a SIPA liquidation should be
able to recover their assets more quickly
through advances from the fund than if
the fund is not adequate. Also, to the
extent the amendments overcome a
potential legal hurdle to pursuing
claims against a broker-dealer’s
accountant, the ability to recover
damages from the broker-dealer’s
accountant in the context of a SIPA
liquidation proceeding could increase
the size of the estate of a failed brokerdealer. Increasing the size of the estate
could benefit customers with claims
that cannot be fully satisfied through
distributions of customer property held
by the failed broker-dealer and the SIPC
advances.
The new requirement that brokerdealers that are members of SIPC file
their annual reports with SIPC will
increase these broker-dealers’
compliance costs.818 In the proposing
release, the Commission estimated that
it would take broker-dealers
approximately 30 minutes to prepare
and file the annual reports with SIPC,
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and commenters did not disagree with
this estimate. Thus, the Commission
estimates that the annual industry-wide
reporting burden associated with this
amendment is approximately 2,246
hours per year (1⁄2 hour times 4,492
SIPC members = 2,246 hours) and that
the total annual cost is approximately
$694,000.819 There would be postage
costs associated with sending a copy of
the annual report to SIPC that are
estimated to be, on average,820
approximately $12.05 per broker-dealer
per year.821 Thus, the Commission
estimates that the total annual postage
costs associated with sending a copy of
the annual report to SIPC would be
approximately $54,128 per year for all
broker-dealers that are SIPC
members.822
While they did not provide estimates
of potential litigation costs, several
commenters stated that the Commission
did not address the potential costs and
benefits of requiring broker-dealers to
file copies of their annual reports with
SIPC, including potential litigation costs
for independent public accountants.823
The Commission recognizes that there
may be increased litigation costs (or
reserves for potential litigation costs) for
accountants as a result of the
amendment and that to the extent that
there are such costs, some of them may
be passed on to broker-dealers in the
819 Based on staff experience, a broker-dealer
likely would have a Financial Reporting Manager
prepare an additional copy of its annual report and
mail it to SIPC. According to the SIFMA Report on
Management and Professional Earnings in the
Securities Industry, as modified by Commission
staff to account for an 1,800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead, the hourly cost of
a Financial Reporting Manager is approximately
$309/hour. 4,492 SIPC-member broker-dealers × 1⁄2
hour × $309 = $694,014.
820 The number of pages of an annual report, and
consequently the associated postage costs, likely
will vary significantly based on the size of the
broker-dealer and the types of business in which it
engages.
821 Based on Commission staff experience with
annual report filings of broker-dealers under Rule
17a–5, the Commission staff estimates that
approximately 50% of broker-dealers file their
annual reports using an overnight mail delivery
service. These broker-dealers would consequently
incur higher postage costs than broker-dealers
which choose to mail their annual reports using
first class mail or delivery methods other than
overnight mail. Therefore, postages costs will vary
depending on the size of the annual report and
method of delivery. The Commission estimates that
the cost to mail the additional reports would be, on
average, $12.05 per broker-dealer. As of October
2012, the $12.05 rate is an average rate of the cost
of an Express Mail Flat Rate Envelope of $18.95 and
a Priority Mail Flat Rate Envelope of $5.15, based
on costs obtained on the Web site of the U.S. Postal
Service, available at www.usps.gov. ($18.95 +
$5.15) = $24.10/2 = $12.05.
822 4,492 broker-dealers × $12.05 = $54,128.
823 See, e.g., CAQ Letter; Deloitte Letter; KPMG
Letter.
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form of increased fees charged by
broker-dealers’ independent public
accountants. However, commenters did
not provide estimates of potential
litigation costs, and Commission staff
were unable to find readily-available
public information from which to
estimate specific costs of possible
litigation. To the extent that SIPC does
bring an individual lawsuit as a direct
result of this amendment (e.g., a suit
brought in New York), there would be
costs in terms of legal fees. Based on
staff experience, depending on the
complexity, scope, and length of the
litigation, the costs to defend an
individual case could be quite signficant
given the hourly fees charged by outside
counsel. However, the Commission does
not believe these costs would be
significant in the aggregate. As indicated
in the economic baseline, SIPC initiates
a small number of proceedings each
year, and most of these proceedings
have not involved litigation by SIPC
against the firm’s independent public
accountant. Moreover, SIPC continued
to bring lawsuits against broker-dealer
accountants after the 2001 New York
decision in jurisdictions other than New
York.824 Consequently, while the
amendment removes one potential legal
hurdle to such suits, it may not
significantly increase the frequency
with which SIPC brings such lawsuits.
Moreover, the other elements of any
relevant cause of action would be
unaffected. Accordingly, the
Commission continues to believe that
the requirement to file copies of the
annual reports with SIPC is appropriate.
v. Notification Requirements
As discussed above in section II.F. of
this release, the Commission is
amending the notification provisions in
Rule 17a–5 and is making conforming
amendments to Rule 17a–11. Prior to
today’s amendments, paragraph (h)(2) of
Rule 17a–5 provided that if, during the
course of the audit or interim work, the
independent public accountant
determined that any ‘‘material
inadequacies’’ existed, the independent
public accountant was required to
inform the CFO of the broker-dealer,
who, in turn, was required to give notice
to the Commission and the brokerdealer’s DEA within 24 hours in
accordance with the provisions of Rule
17a–11.825
Under Rule 17a–11, a broker-dealer
must provide notice to the Commission
and its DEA in certain circumstances.826
824 See SIPC v. BDO Seidman, LLP, 746 NE.2d
1042 (N.Y. 2001); aff’d, 245 F.3d 174 (2d Cir. 2001).
825 See 17 CFR 240.17a–5(h)(2).
826 See 17 CFR 240.17a–11.
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For example, paragraph (b)(1) of Rule
17a–11 requires a broker-dealer to give
notice if its net capital declines below
the minimum amount required under
Rule 15c3–1.827 Before today’s
amendments, Rule 17a–11 required that
whenever a broker-dealer discovered, or
was notified by an independent public
accountant of the existence of any
material inadequacy, the broker-dealer
must give notice to the Commission and
transmit a report to the Commission
stating what the broker or dealer has
done or is doing to correct the situation.
Rule 15c3–1 and Rule 15c3–3 also
require broker-dealers to provide
notification in certain circumstances.828
For example, paragraph (i) of Rule
15c3–3 requires a carrying broker-dealer
to immediately notify the Commission
and its DEA if it fails to make a deposit
into its customer reserve account as
required by paragraph (e) of Rule 15c3–
3.829
a. Amendments to Rule 17a–5
The Commission proposed amending
the notification provisions in Rule 17a–
5 to replace the term ‘‘material
inadequacy’’ with the term ‘‘material
non-compliance.’’ The term ‘‘material
non-compliance’’ was defined in the
context of the compliance report, which
was required to be prepared and filed by
carrying broker-dealers. This provision
would therefore have applied to brokerdealers that filed compliance reports
with the Commission. The Commission
also proposed amending the notification
process. Under the proposed new
process, the accountant would be
required to notify the Commission and
the broker-dealer’s DEA directly.
The Commission received numerous
comments in response to this
proposal.830 Most of these commenters
objected to the proposed notification
process.831 Among the reasons given
were that it would be inappropriate to
require the accountant to notify the
Commission and the DEA directly,
because, among other things, the brokerdealer is principally responsible for
compliance with the securities laws,
827 See
17 CFR 240.17a–11(b)(1).
e.g., 17 CFR 240.15c3–1(a)(6)(iv)(B); 17
CFR 240.15c3–1(a)(6)(v); 17 CFR 240.15c3–
1(a)(7)(ii); 17 CFR 240.15c3–1(c)(2)(x)(C)(1); 17 CFR
240.15c3–1(e); 17 CFR 240.15c3–1d(c)(2); 17 CFR
240.15c3–3(i).
829 See 17 CFR 240.15c3–3(i).
830 See ABA Letter; CAI Letter; CAQ Letter;
Deloitte Letter; E&Y Letter; Grant Thornton Letter;
KPMG Letter; McGladrey Letter; PWC Letter; SIFMA
Letter; Van Kampen/Invesco Letter.
831 See ABA Letter; CAI Letter; CAQ Letter;
Deloitte Letter; E&Y Letter; Grant Thornton Letter;
KPMG Letter; McGladrey Letter; PWC Letter; Van
Kampen/Invesco Letter.
828 See,
PO 00000
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51979
including timely notification; 832 that
PCAOB standards provide that ‘‘the
practitioner should not take on the role
of the responsible party’’ 833; and that
PCAOB attestation standards (which
were referenced in the proposing
release) clearly provide that
management is responsible for the
subject matter to which it is asserting,
and not the accountant.834 In addition to
suggestions that the notification process
that existed prior to today’s
amendments should not be changed,835
one commenter stated that the rule
should require simultaneous notice by
the accountant to the Commission and
to the firm’s management.836 In
addition, one commenter asked whether
the notification provisions apply to a
review of the exemption report.837
Another commenter stated that noncompliance also will trigger a Rule 17a–
11 notice, which would be duplicative
and create confusion.838
The final rule requires that if the
accountant determines that there are
any instances of non-compliance (as
opposed to an instance of material noncompliance, as proposed) with the
financial responsibility rules during the
course of preparing the accountant’s
reports, the accountant must
immediately notify the CFO of the
broker-dealer of the nature of the noncompliance. If the accountant provides
notice of an instance of non-compliance,
the broker-dealer must notify the
Commission and its DEA, but only if
required to do so by existing provisions
of Rule 15c3–1, Rule 15c3–3, or Rule
17a–11 that require such notification.839
832 See
Deloitte Letter.
KPMG Letter. See also PCAOB Interim
Attestation Standard, AT Section 101 at ¶ 13.
834 See PWC Letter. See also PCAOB Interim
Attestation Standard, AT Section 101 at ¶¶ 11–13.
835 See, e.g., ABA Letter; E&Y Letter; McGladrey
Letter.
836 See Van Kampen/Invesco Letter.
837 See KPMG Letter.
838 See ABA Letter.
839 Under Rule 17a–11, a broker-dealer must
provide notice to the Commission and its DEA in
certain circumstances. For example, paragraph
(b)(1) of Rule 17a–11 requires a broker-dealer to
give notice if its net capital declines below the
minimum amount required under Rule 15c3–1. In
addition, Rule 15c3–1 and Rule 15c3–3 require
broker-dealers to provide notifications in certain
circumstances. For example, paragraph (a)(6)(iv) of
Rule 15c3–1 requires a broker-dealer that operates
as a specialist or market-maker and that operates
under the provisions of paragraph (a)(6) of Rule
15c3–1 to obtain certain representations from the
broker-dealer that carries its market maker or
specialist account. The representations include that
the broker-dealer carrying the account will provide
a notification under Rule 17a–11 if the market
maker or specialist fails to deposit the required
amount of equity into the account within the
required time frame as prescribed in paragraph
(a)(6) of Rule 15c3–1. In addition, under paragraph
833 See
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Consequently, the final rule requires
that any instance of non-compliance
identified by the accountant will trigger
a notification by the broker-dealer to the
Commission and the firm’s DEA to the
same extent that notification is required
if discovered by the broker-dealer other
than in connection with its annual
audit. Therefore, under the final rule, if
the accountant determines that an
instance of non-compliance with the
financial responsibility rules exists, the
accountant is not required to make a
determination of whether that instance
of non-compliance is material. This
modification likely will result in a lower
burden relative to the proposal on the
independent public accountant as the
accountant will not need to analyze
whether an instance of non-compliance
is material to determine whether the
notification requirement has been
triggered. On the other hand, the
independent public accountant will
need to provide notice to the brokerdealer of all instances of noncompliance rather than only instances
of material non-compliance. Therefore,
the modification will result in more
required notifications from the
independent public accountant to the
broker-dealer.
Under the final rule, the independent
public accountant also will be required
to provide notice to the broker-dealer if
the accountant determines that any
material weaknesses exist. As in the
proposal, material weakness is defined
with regard to the compliance report
and therefore applies only to brokerdealers that file compliance reports. In
that report, a carrying broker-dealer
must state whether its internal controls
were effective during the fiscal year as
well as at the end of the fiscal year.
Internal controls are not effective if
there are one or more material
weaknesses in the controls. The brokerdealer also is required to describe any
identified material weaknesses. The
independent public accountant must
undertake to prepare a report based on
an examination of certain statements in
the compliance report, including the
statements as to whether the carrying
broker-dealer’s internal controls were
effective.
As stated above, before today’s
amendments, Rule 17a–5 required the
accountant to notify the broker-dealer if
the accountant determined that any
material inadequacies existed. The
concept of material inadequacy
generally applied to all broker-dealers
(i) of Rule 15c3–3, a carrying broker-dealer must
immediately notify the Commission and its DEA if
it fails to make a deposit into its customer reserve
account as required by paragraph (e) of Rule
15c3–3.
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and, therefore, the notification
requirement applied with respect to
independent public accountant
engagements for non-carrying as well as
carrying broker-dealers under Rule 17a–
5. This requirement, however, may not
have produced the intended benefits.
As discussed in section II.D.3. above,
PCAOB inspection staff found that in 21
of 23 broker-dealer audits inspected, the
accountant ‘‘failed to perform sufficient
audit procedures to obtain reasonable
assurance that any material
inadequacies found to exist since the
date of the last examination . . . would
have been disclosed in the accountant’s
supplemental report.’’ 840 Material
inadequacies which were expected to be
reported by the accountant included any
condition which contributed
substantially to or, if appropriate
corrective action was not taken, could
reasonably be expected to: (1) Inhibit a
broker-dealer from promptly completing
securities transactions or promptly
discharging its responsibilities to
customers, other broker-dealers, or
creditors; (2) result in material financial
loss; (3) result in material misstatements
of the broker-dealer’s financial
statements; or (4) result in violations of
the Commission’s recordkeeping or
financial responsibility rules to an
extent that could reasonably be
expected to result in the conditions
described in (1) through (3) above. The
definition of material weakness is more
specific: a material weakness includes a
deficiency in internal control such that
there is a reasonable possibility that
non-compliance with Rule 15c3–1 and
paragraph (e) of Rule 15c3–3 will not be
prevented or detected on a timely basis
or that non-compliance to a material
extent with Rule 15c3–3, except
paragraph (e), Rule 17a–13, or the
Account Statement Rules will not be
prevented or detected on a timely basis.
As discussed above, today’s
amendments generally replace the term
material inadequacy and separate it into
two components—a compliance
component (non-compliance with the
financial responsibility rules) and, for
carrying broker-dealers, an internal
control component (material weakness
in Internal Control Over Compliance).
The change is consistent with one of the
objectives of the amendments: to
provide clear and consistent
terminology focused separately on
compliance with key financial
responsibility rules and internal control
over compliance with the financial
responsibility rules. The amended
notification provisions in Rule 17a–5
reflect this change in terminology.
840 See
PO 00000
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The Commission proposed amending
the notification process so that the
accountant would be required to notify
the Commission and the broker-dealer’s
DEA directly. However, the Commission
is not adopting this alternative because
it agrees with the comments, discussed
above, that the notification process in
place before today’s amendments
should be retained.
As stated above, Rule 17a–5 before
today’s amendments required the
accountant to notify the broker-dealer,
and the broker-dealer to notify the
Commission, if the accountant
determined during the course of the
audit or interim work that a material
inadequacy existed. This requirement
generally applied to all broker-dealer
audits. The notification provisions in
themselves did not direct the
accountant to perform specific
procedures with respect to the audit—
those requirements were contained in
other provisions of Rule 17a–5. The
notification provisions in Rule 17a–5
were intended to require notification if,
during the course of the audit, the
accountant became aware of any
material inadequacies. As amended, the
notification provisions in Rule 17a–5
likewise do not in themselves require
the accountant to perform specific
procedures with respect to the
examination of the financial report or an
examination of a compliance report or
review of an exemption report. Instead,
the notification provisions are triggered
when the accountant becomes aware,
during the course of preparing the
reports of the accountant required under
Rule 17a–5, that the broker-dealer is not
in compliance with the financial
responsibility rules or, during the
course of preparing a report based on an
examination of a compliance report, that
a material weakness exists. These
notification requirements are designed
to put the broker-dealer in a position to
correct controls, processes, and systems
that have caused or potentially could
cause the firm to not comply with the
financial responsibility rules. As
discussed throughout this release, the
financial responsibility rules serve an
important investor protection function
by requiring broker-dealers to maintain
prudent levels of net capital and take
steps to safeguard customer securities
and cash.
The requirement to notify the brokerdealer when the independent public
accountant determines that the brokerdealer is not in compliance with the
financial responsibility rules or that any
material weaknesses exist is not
expected to increase costs for brokerdealers when compared to the baseline
requirement to provide the broker-
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dealer with notice when the
independent public accountant
determines that a material inadequacy
exists. As discussed above, the notice
requirements under today’s
amendments do not require the
independent public accountant to
perform specific procedures. Instead,
they are triggered when the independent
public accountant determines that any
non-compliance or material weakness
exists during the course of performing
procedures to examine the financial
report and to examine the compliance
report or review the exemption report,
as applicable. To the extent the
obligation to provide the broker-dealer
with notice is factored into the fee
charged by the accountant, the
Commission notes that before today’s
amendments the independent public
accountant was required to give notice
of a material inadequacy. This
notification requirement has been
eliminated and, therefore, to the extent
it was factored into the fee, that cost has
been eliminated. The Commission does
not believe that the component of the
independent public accountants’ fee
associated with the new notification
requirements would be materially
different than the component of the fee
associated with the material inadequacy
notification requirements. Therefore, the
Commission believes these
requirements would not result in
increased compliance costs relative to
the requirements in place before today’s
amendments.
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b. Conforming and Technical
Amendments to Rule 17a–11
As discussed above in section II.F.2.,
prior to today’s amendments, paragraph
(e) of Rule 17a–11 required that
whenever a broker-dealer discovered, or
was notified by an independent public
accountant, pursuant to paragraph (h)(2)
of Rule 17a–5 or paragraph (f)(2) of Rule
17a–12, of the existence of any material
inadequacy, the broker-dealer was
required to give notice to the
Commission and transmit a report to the
Commission stating what the brokerdealer has done or is doing to correct
the situation.
The Commission is adopting
conforming amendments to paragraph
(e) of Rule 17a–11 to substitute a notice
of the existence of any material
weakness as defined in paragraph
(d)(3)(iii) of Rule 17a–5 for a notice of
the existence of any material
inadequacy and to replace a reference to
paragraph (h)(2) of Rule 17a–5 with a
reference to paragraph (h) of Rule 17a–
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5.841 Specifically, the final rule provides
that whenever a broker-dealer discovers,
or is notified by its accountant under
paragraph (h) of Rule 17a–5 of the
existence of any material weakness, the
broker-dealer must: (1) Give notice of
the material weakness within 24 hours
of the discovery or notification; and (2)
transmit a report within 48 hours of the
notice stating what the broker-dealer has
done or is doing to correct the
situation.842
The notification requirements, among
other things, alert the Commission and
the DEA of the need to increase their
monitoring of a broker-dealer and to
obtain additional information when
appropriate in order to address any
concerns the Commission or the DEA
may have as a result of the notification.
A notification of a material weakness
will alert the Commission and the
broker-dealer’s DEA to the existence of
a condition that could impact the
broker-dealer’s ability to remain in
compliance with the financial
responsibility rules, which serve an
important investor protection function
by requiring broker-dealers to maintain
prudent levels of net capital and take
steps to safeguard customer securities
and cash. Once alerted, the Commission
and the DEA can respond to the
situation through, for example,
heightened monitoring of the brokerdealer to assess whether it has corrected
the problem and whether it is properly
safeguarding customer securities and
cash.
The Commission believes these
amendments will not result in increased
compliance costs to broker-dealers.
Material weakness is defined with
regard to the compliance report and
therefore applies only to broker-dealers
that file compliance reports (i.e.,
carrying broker-dealers). In contrast, the
concept of material inadequacy
generally applied to all broker-dealers
and, therefore, the notification
requirement applied with respect to
independent public accountant
engagements under Rule 17a–5 for noncarrying as well as carrying brokerdealers. As discussed above in section
VII.B.1. of this release, the Commission
estimates that there are approximately
4,709 broker-dealers registered with the
Commission and that of those firms,
approximately 292 are carrying brokerdealers. Consequently, before today’s
amendments, the notification
841 The final rule retains a reference to material
inadequacy as defined in paragraph (h)(2) of Rule
17a–12, but amendments correct citations to that
rule.
842 See paragraph (e) of Rule 17a–11. The rule
retains provisions referencing the term material
inadequacy as defined in Rule 17a–12.
PO 00000
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51981
requirements with respect to material
inadequacy applied to approximately
4,709 broker-dealers, whereas after
today’s amendments the notification
requirement with respect to material
weakness will apply to approximately
292 broker-dealers.
The Commission proposed amending
paragraph (e) of Rule 17a–11 to delete
the references to Rule 17a–5. However,
the Commission is not adopting this
alternative because it agrees with a
commenter that notification should be
provided to the Commission when a
deficiency in internal control is
discovered by the broker-dealer. 843
vi. Information Provided to Customers
Prior to today’s amendments,
paragraph (c)(2)(iii) of Rule 17a–5
provided that if, in conjunction with a
broker-dealer’s most recent audit report,
the broker-dealer’s independent public
accountant commented on any material
inadequacies in the broker-dealer’s
internal controls, its accounting system,
or certain of its practices and
procedures844 under paragraphs (g) and
(h) of Rule 17a–5, and paragraph (e) of
Rule 17a–11, the broker-dealer’s audited
statements sent to customers were
required to include a statement that a
copy of the auditor’s comments were
available for inspection at the
Commission’s principal office in
Washington, DC, and the regional office
of the Commission in which the brokerdealer had its principal place of
business.845
The Commission is revising its
proposal with respect to amending
paragraph (c)(2) of Rule 17a–5 to be
consistent with the new notification
provisions in paragraph (h) described
above relating to the identification by a
broker-dealer’s accountant of a material
weakness rather than an instance of
material non-compliance.846
Specifically, if, in connection with the
most recent annual reports, the report of
the independent public accountant on
the broker-dealer’s compliance report
identifies a material weakness, the
broker-dealer must include a statement
that one or more material weaknesses
have been identified and that a copy of
the report of the independent public
accountant is currently available for the
customer’s inspection at the principal
office of the Commission in
Washington, DC, and the regional office
of the Commission for the region in
843 See
Deloitte Letter.
practices and procedures include, for
example, periodic net capital computations under
Rule 15c3–1 and periodic counts of securities under
Rule 17a–13.
845 See 17 CFR 240.17a–5(c)(2)(iii).
846 See paragraph (c)(2)(iv) of Rule 17a–5.
844 These
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which the broker-dealer has its
principal place of business.847
The Commission does not believe
these amendments will result in
incremental costs to broker-dealers over
the baseline. Material weakness is
defined with regard to the compliance
report and therefore applies only to
broker-dealers that file compliance
reports (i.e., carrying broker-dealers). In
contrast, the concept of material
inadequacy generally applied to all
broker-dealers and, therefore, the
customer notification requirement
applied with respect to independent
public accountant engagements under
Rule 17a–5 for non-carrying as well as
carrying broker-dealers. As discussed
above in section VII.B.1. of this release,
the Commission estimates that there are
approximately 4,709 broker-dealers
registered with the Commission and that
of those firms, approximately 292 are
carrying broker-dealers. Consequently,
before today’s amendments, the
notification requirements with respect
to material inadequacy applied to
approximately 4,709 broker-dealers,
whereas after today’s amendments the
notification requirement with respect to
material weakness will apply to
approximately 292 broker-dealers.
Rule 17a–5 also provides a
conditional exemption from the
requirement to send paper copies of
financial information to customers if the
broker-dealer mails a financial
disclosure statement with summary
information and an Internet link to the
balance sheet and other information on
the broker-dealer’s Web site. Before
today’s amendments, one of the
conditions of the exemption was that
the broker-dealer was not required
during the prior year to give notice of
a material inadequacy. The Commission
proposed revising this condition for
using Web site disclosure to provide
that the broker-dealer’s financial
statements must receive an unqualified
opinion from the accountant and that
neither the broker-dealer nor the
accountant identified a material
weakness or an instance of material
non-compliance.
One commenter stated that a brokerdealer should be able to deliver the
financial information available to
customers via its Web site regardless of
whether an instance of material noncompliance or material weakness was
identified.848 Another commenter stated
that the rule should not require a 100%
rate of compliance with the financial
responsibility rules to qualify for the
847 Id.
848 See
ABA Letter.
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exemption.849 A third commenter stated
that the proposed amendment should be
eliminated, or replaced with the
requirement that broker-dealers include
a notice of the material weakness or
non-compliance on customer account
statements for a year following its
identification.850
The Commission has decided not to
adopt the proposed condition for
qualifying for the conditional
exemption. The decision not to adopt
should result in lower costs than would
have been incurred had the Commission
adopted the proposal without
modification. Using the Internet to
disclose information should be less
costly and more efficient for the brokerdealer than mailing paper copies to all
customers. It also will benefit
customers, since they will be able to
access relevant broker-dealer
information more efficiently through the
Internet (alternatively, customers can
request a paper copy by phone at no
cost to the customer).851
vii. Coordination With Investment
Advisers Act Rule 206(4)–2
Advisers Act Rule 206(4)–2 provides
that when a registered investment
adviser or its related person maintains
client funds and securities as a qualified
custodian in connection with advisory
services provided to clients, the adviser
annually must obtain, or receive from its
related person, a written internal control
report prepared by an independent
public accountant registered with, and
subject to regular inspection by, the
PCAOB. This report must be supported
by the accountant’s examination of the
qualified custodian’s custody controls.
Under the amendments, a broker-dealer
that also acts as a qualified custodian for
itself as an investment adviser or for its
related investment advisers may use the
report of the independent public
accountant based on an examination of
its compliance report to meet the
reporting obligations under Rule 206(4)–
2. Therefore, such a broker-dealer will
not be required to obtain an internal
control report under Rule 206(4)–2 in
849 See CAI Letter. This commenter stated that
FINRA has proposed that broker-dealers send
customer account statements monthly instead of
quarterly, broker-dealers are already potentially
facing ‘‘extremely high’’ costs of sending
information to customers. FINRA withdrew its
proposals to send customer account statements
monthly instead of quarterly on July 30, 2012. See
SR–FINRA–2009–028, Proposed Rule Change to
Adopt FINRA Rule 2231 (Customer Account
Statements) in the Consolidated FINRA Rulebook,
Withdrawal of Proposed Rule Change (July 30,
2012), available at https://www.finra.org/web/
groups/industry/@ip/@reg/@rulfil/documents/
rulefilings/p143262.pdf.
850 See SIFMA Letter.
851 See 17 CFR 240.17a–5(c)(5)(ii), (iv), and (v).
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addition to a report covering the
compliance report from its independent
public accountant. It also will result in
efficiencies as a single audit will be able
to address two audit requirements.
2. Access to Accountant and Audit
Documentation
The amendments to Rule 17a–5
require that carrying or clearing brokerdealers agree to allow Commission and
DEA staff, if requested in writing for
purposes of an examination of the
broker-dealer, to review the work papers
of the independent public accountant
and to allow the accountant to discuss
the its findings with the examiners.
This requirement will enable the
Commission and DEAs to more
efficiently deploy examination
resources.852 Examiners reviewing the
accountant’s work papers will be able to
tailor the scope of their examinations by
identifying areas where extensive audit
work was performed by the independent
public accountant and focusing their
examinations on other areas, allowing
for more efficient oversight of brokerdealers by the Commission and DEA
examination staff. Enabling Commission
and DEA examination staff to conduct
more focused and efficient examinations
of broker-dealers could, in turn, allow
for examination resources to be
allocated more strategically.
The Commission is amending
paragraph (f)(2) of Rule 17a–5 to revise
the statement regarding identification of
a broker-dealer’s independent public
accountant that broker-dealers must file
each year with the Commission and
their DEA (except that if the engagement
is of a continuing nature, no further
filing is required).853 The revised
statement contains additional
information that includes a
representation that the independent
public accountant has undertaken to
provide a report regarding the brokerdealer’s financial reports and a report
regarding the broker-dealer’s
compliance or exemption report, as
applicable.854 In addition, the statement
provided by a clearing or carrying
broker-dealer must include
representations regarding the access to
accountant requirements described
above.855 Therefore, all broker-dealers
will generally be required to file a new
852 As discussed previously, where an
independent public accountant has performed
extensive testing of a carrying broker-dealer’s
custody of securities and cash by confirming
holdings at subcustodians, examiners could focus
their efforts on matters that had not been the subject
of prior testing and review.
853 See discussion above in section III. of this
release.
854 See 17 CFR 240. 17a–5(f)(2)(ii).
855 See 17 CFR 17a–5(f)(2)(ii)(F)–(G).
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statement regarding their independent
public accountant.
As discussed above in section III. of
this release, one commenter stated that,
the amendments would discourage or
‘‘chill’’ communications between a
broker-dealer and its auditor because of
the possibility that an auditor may
misconstrue communications from
representatives of the broker-dealer and
wrongly conclude that the
representatives lack knowledge or admit
to an issue.856 Presumably, this
‘‘chilling effect’’ would result from a
broker-dealer’s desire to avoid the
creation of audit documentation
memorializing misunderstandings and
miscommunications, which when
accessed by Commission and DEA
examiners could result in regulatory
scrutiny. As stated in section III. of this
release, the Commission is not
persuaded by this comment; while it is
possible for miscommunications to
occur between representatives of a
broker-dealer and its auditor, potential
misunderstandings or
miscommunications should not limit
the ability of the Commission or a DEA
to have access to audit documentation
or a broker-dealer’s independent public
accountant. Further, to the extent a
misunderstanding or
miscommunication between a brokerdealer and its accountant is reflected in
the accountant’s audit documentation
relating to the broker-dealer, the brokerdealer could clarify the nature of the
misunderstanding or
miscommunication to examiners and
how it was rectified if such clarification
and rectification is not already
described in subsequent audit
documentation.
The Commission estimated that the
one-time hour burden associated with
amending its existing statement and
filing the new statement with the
Commission, in order to comply with
the proposed amendments, would be an
average of approximately two hours on
a one-time basis for each broker-dealer,
as the statement can be continuing in
nature.857
As discussed in the PRA, the
Commission is revising this estimate for
clearing and carrying broker-dealers, as
these broker-dealers will likely be
required to renegotiate their agreements
with their independent public
accountants. The Commission estimates
that the total one-time cost associated
with this burden is approximately $5.2
million.858 Additionally, the
856 See
CAI Letter.
857 See Broker-Dealer Reports, 76 FR at 37596.
858 See Section VI.D.1.vi. Based on staff
experience, a broker-dealer that carries customer
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Commission believes there will be
postage costs associated with sending
the amended statement regarding the
accountant and estimates that each
mailing will cost approximately $0.45,
for a total cost of approximately $6,357
for all broker-dealers on a one-time
basis.859
In addition, in the proposing release,
the Commission estimated that a
carrying or clearing broker-dealer’s
accountant would charge the brokerdealer for time its personnel spend
speaking with the Commission or the
broker-dealer’s DEA or providing them
with audit documents and that, on
average, the Commission or the brokerdealer’s DEA may speak with each
accountant for approximately five hours
per year. Thus, the Commission
estimated that the additional cost of
accountant time associated with this
amendment to all clearing and carrying
broker-dealers would be approximately
$660,000 annually.860 As the
Commission now estimates that the
number of carrying or clearing brokerdealers is 513, the new estimate is
approximately $641,250.861
3. Form Custody
The newly adopted Form Custody is
to be filed quarterly at the same time
that a broker-dealer is required to file its
FOCUS Reports. The form elicits
information concerning whether, and if
so, how, a broker-dealer maintains
custody of customer assets and, as
discussed above, consolidates
accounts or clears transactions likely would have its
Controller and an Assistant General Counsel
involved in renegotiating the agreement with
auditors, and that those discussions would take, on
average, approximately four hours. Broker-dealers
would likely have an attorney prepare a new
notification of designation of accountant, and that
task would take the attorney, on average,
approximately two hours. According to the SIFMA
Report on Management and Professional Earnings
in the Securities Industry, as modified by
Commission staff to account for an 1,800-hour
work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead,
the hourly cost of a Controller is approximately
$409/hour, the hourly cost of an Assistant General
Counsel is approximately $407/hour, and the
hourly cost of an Attorney is approximately $378/
hour. 513 broker-dealers that carry customer
accounts or clear transactions × 4 hours × $409 =
$839,268. 513 broker-dealers that carry customer
accounts or clear transactions × 4 hours × $407 =
$835,164. 4,709 broker-dealers × 2 hours × $378 =
$3,560,004. $839,268 + $835,164 + $3,560,004 =
$5,234,436.
859 See Section VI.D.1.vi. 4,709 broker-dealers ×
$0.45 cost for first class postage × 3 mailings =
$6,375.15.
860 See Section VI.D.1.vii.d. In the proposing
release the Commission multiplied 528 clearing and
carrying broker-dealers × 5 hours × $250/hour =
$660,000.
861 See Section VI.D.1.vii.d. 513 clearing and
carrying broker-dealers × $1,250 in increased costs
per clearing broker-dealer = $641,250.
PO 00000
Frm 00075
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51983
information about the broker-dealer’s
custodial responsibility and
relationships with other custodians in
one report so that the Commission and
other securities regulators will be
provided with a comprehensive profile
of the broker-dealer’s custody practices
and arrangements. This should reduce
the likelihood that fraudulent conduct,
including misappropriation or other
misuse of investor assets, can continue
undetected. Further, the information
provided in Form Custody should aid in
the examination of broker-dealers,
because the examination staff can use
the information provided as another tool
to prioritize and plan examinations.
The Form Custody amendments also
should enhance investor confidence in
the ability of the securities regulators to
oversee broker-dealers and broker-dealer
custody of investor assets. By
establishing a discipline under which
broker-dealers are required to report
greater detail as to their custodial
functions, investor perception as to the
safety of their funds and securities held
by broker-dealers should improve.
Investors may be more willing to
provide capital for investment. Further,
the requirement by broker-dealers to
provide detail as to their custodial
practices may prompt them to identify
and correct deficiencies. For example, if
a broker-dealer preparing the
information to be disclosed on the form
discovers a discrepancy between its
own records and the records of a
custodian as to the nature or quantity of
assets held by the custodian, the brokerdealer can act to resolve the discrepancy
before filing the form.
The Commission estimated that the
time required to complete and file Form
Custody would be approximately 12
hours per quarter, or 48 hours per year,
on average, for each broker-dealer.862
The Commission did not receive
comments regarding this estimate. The
Commission now estimates that there
are approximately 4,709 broker-dealers
that must file Form Custody. The
Commission therefore estimates that the
total time required to complete and file
Form Custody for all 4,709 brokerdealers is approximately 226,032 hours
per year (4,709 broker-dealer times four
responses per year times 12 hours =
226,032 hours). Further, the
Commission estimates that the total cost
associated with completing and filing
Form Custody is approximately $69.8
million.863
862 See
Broker-Dealer Reports, 76 FR at 37597.
on staff experience, a broker-dealer
likely would have a Financial Reporting Manager
complete and file Form Custody. According to the
863 Based
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One commenter stated that the
estimated costs to the industry of
$69,179,670 in the proposing release
was ‘‘staggering,’’ and that such costs
would likely indirectly be passed on to
customers.864 The commenter did not
disagree with the estimated cost in the
proposing release; rather, the
commenter focused on the size of the
total estimated costs. The Commission
notes that the $69 million estimate in
the proposing release and the $69.8
million estimate in this release are
estimates of the aggregate cost to the
industry. The average cost to an
individual broker-dealer would be
approximately $15,000 per year.865 As
an average, the costs incurred by a
broker-dealer to comply with the
requirement to file Form Custody will
depend on its size and the complexity
of its business activities.
The Commission recognizes that the
requirement to file Form Custody will
increase compliance costs for brokerdealers and that these costs may be
passed on to customers. The
Commission, however, believes the
investor protection benefits of the Form
Custody requirements outweigh these
costs. As noted above, Form Custody is
designed to assist Commission and DEA
examiners in identifying potential
misrepresentations relating to brokerdealers’ custody of assets. Further, the
requirements to file the form will
promote greater focus and attention to
custody practices by requiring that
broker-dealers make specific
representations in this regard. The
safeguarding of customer securities and
cash held by broker-dealers is of
paramount importance as demonstrated
by recent cases where broker-dealers
failed to protect customer securities and
cash.866
SIFMA Report on Management and Professional
Earnings in the Securities Industry, as modified by
Commission staff to account for an 1,800-hour
work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead,
the hourly cost of a Financial Reporting Manager is
approximately $309/hour. 4,709 broker-dealers × 48
hours × $309 = $69,843,888.
864 See IMS Letter. The cost of $69,179,670 was
reflected in the economic analysis in the proposing
release. See Broker-Dealer Reports, 76 FR at 37601.
This cost was calculated as an internal cost of the
estimated PRA hours and is the total cost divided
among 5,057 firms. Id. at 37601 n.215. This internal
cost would amount to an average of $13,680 per
broker-dealer. Id.
865 1 broker-dealer × 48 hours × $309 = $14,832.
866 See, e.g., SEC v. Bernard L. Madoff, et al.,
Litigation Release No. 20889 (Feb. 9, 2009).
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4. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
As discussed above, incremental costs
will result from the annual reporting
requirement amendments, the access to
accountant amendments, and the Form
Custody amendments. These
incremental costs could result in higher
barriers to entry for broker-dealers as
compared with the baseline that existed
prior to the amendments. This could be
the case particularly for carrying brokerdealers given the incremental costs
associated with the compliance report
requirements, the applicability of the
access to accountant amendments to
carrying and clearing broker-dealers,
and that most of the information elicited
in Form Custody relates to carrying
broker-dealer activities.
The annual reporting requirements
have a mixed effect on competition
across broker-dealers. The requirement
to prepare and file a compliance report
or exemption report may impose a
burden on competition for smaller
carrying broker-dealers to the extent that
it imposes relatively high fixed costs,
which would represent a greater amount
of net income for smaller broker-dealers.
On the other hand, as previously noted,
a carrying broker-dealer with limited
custodial activities should have to
expend less effort to support its
statements in the compliance report
than a broker-dealer with more
extensive custodial activities, and the
attendant costs should similarly be
lower. While the incremental costs of
the annual reporting requirements may
be lower for non-carrying broker-dealers
(which generally are smaller brokerdealers), the costs could
disproportionately impact smaller
broker-dealers due to fixed cost
components of the cost of compliance
with these requirements.
The access to accountant amendments
may place a burden on carrying and
clearing broker dealers. To the extent
that addressing contracts between
auditors and broker-dealers is a fixed
cost, the rule may impact smaller
broker-dealers to a greater extent than it
will larger broker-dealers. The
amendments should not place a burden
on competition for non-carrying brokerdealers.
The requirement to file Form Custody
could have a burden on competition
because it will increase compliance
costs for broker-dealers. However, the
requirement should not have a
disproportionate effect on smaller
broker-dealers. Smaller firms will incur
fewer costs to complete Form Custody
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Frm 00076
Fmt 4701
Sfmt 4700
because less information is required to
be disclosed. For example, brokerdealers that introduce customers on a
fully disclosed basis and do not have
custody of customer funds or assets
would leave much of the form blank.
In sum, the costs of compliance
resulting from the requirements in these
amendments should not impose a
burden on competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act and in
light of the benefits discussed above.
Today’s amendments are designed to
reduce the likelihood that fraudulent
conduct, or lack of appropriate custody
procedures or other internal controls,
will jeopardize customer securities and
funds held by broker-dealers. To the
extent that the amendments achieve that
goal, investors should be more confident
that the customer assets held by brokerdealers are safe. This in turn may
promote capital formation as investor
assets are able to be allocated more
efficiently across the opportunity set.
One commenter asserted that the
proposed amendments ‘‘place
unnecessary regulatory burdens and
costs on industry, in general, and
smaller firms, in particular’’ and that
‘‘broker-dealers compete against
investment advisers who are not
burdened by the same regulatory
requirements,’’ including the
requirements in the proposed
amendments.867 The Commission
recognizes, as explained above, that the
amendments adopted today impose
costs on broker-dealers that could result
in higher barriers to entry. However, the
Commission is of the opinion that these
costs are justified by the numerous and
significant benefits, in particular with
respect to protection of customer assets,
described in this economic analysis.
With respect to the commenter’s
statement about broker-dealers
competing with investment advisers,
recent Commission amendments to
investment adviser rules are ‘‘designed
to provide additional safeguards . . .
when a registered adviser has custody of
client funds or securities’’ including a
requirement to undergo an annual
surprise examination by an independent
public accountant to verify client assets
and a requirement to have a report of
the internal controls relating to the
custody of client assets from an
accountant registered with, and subject
to inspection by, the PCAOB unless
client assets are maintained by an
independent custodian.868
Consequently, the regulations governing
867 See
IMS Letter.
Custody of Funds or Securities of Clients
by Investment Advisers, 75 FR at 1456.
868 See
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investment advisers have been
strengthened in recent years through
new requirements aimed at safeguarding
customer assets. Today’s amendments
also are aimed at safeguarding customer
assets. As both investment advisers and
broker-dealers are now subject to new
requirements, today’s amendments
should not create a competitive
advantage for either class of registrant.
Moreover, the recently adopted
requirements for investment advisers
and the amendments adopted today are,
among other things, part of an effort to
strengthen the Commission’s rules
regarding the safekeeping of customer
assets, in part in response to several
fraud cases brought by the Commission
involving investment advisers and
broker-dealers.869
If the amendments increase investor
confidence in broker-dealers, they will
promote capital formation. Moreover,
for the reasons discussed above, today’s
amendments should not unduly restrict
competition and should promote capital
formation.870
The amendments also should increase
efficiencies. With respect to the annual
reporting amendments, updating the
language of Rule 17a–5 to replace
outdated or inconsistent audit
terminology is designed to ensure that
the requirements of the rule are better
aligned with applicable current audit
standards. Further, the amendments
facilitate PCAOB oversight authority,
including its ability to inspect audits of
broker-dealers, by providing that
examinations or reviews of brokerdealer annual reports be made in
accordance with PCAOB standards. In
addition, the amendments strengthen
and promote consistent compliance
with the financial responsibility rules
for broker-dealers that maintain custody
of customer securities and funds by
increasing the focus of these brokerdealers and their independent public
accountants on compliance, and
internal control over compliance, with
the financial responsibility rules. This,
in turn, should help the Commission
and the broker-dealer’s DEA identify
broker-dealers that have weak internal
controls for safeguarding investor assets
and improve the financial and
operational condition of broker-dealers
and thereby provide more protection for
investor assets held by broker-dealers.
869 Id.
870 The Commission stated in the proposing
release that its preliminary view was that the
proposed rule amendments promote efficiency,
competition, and capital formation and that any
burden on competition is justified by the benefits
provided by the amendments. See Broker-Dealer
Reports, 76 FR at 37598.
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The access to accountant amendments
should increase efficiencies by
promoting more risk-based
examinations by Commission and DEA
staff. For example, the examiners in
some cases may be able to leverage the
work performed by the independent
public accountants and, therefore, focus
on areas the accountants did not review.
Similarly, the Form Custody
amendments should increase
efficiencies by promoting more riskbased examinations by Commission and
DEA staff as they will be able to use the
profile of the broker-dealer’s custody
practices documented in Form Custody
to focus their reviews. For this reason,
examinations may also place fewer time
demands on broker-dealer personnel.
In significant part, the effect of these
rules on efficiency and capital formation
are linked to the effect of these rules on
competition. For example, markets that
are competitive and trusted may be
expected to promote the efficient
allocation of capital. Similarly, rules
that promote, or do not unduly restrict,
trust in broker-dealers can be
accompanied by regulatory benefits that
minimize the risk of market failure and
thus promote efficiency within the
market. Such competitive markets
would increase the efficiency by which
market participants could transact with
broker-dealers.
51985
on a substantial number of small
entities.’’ 875
The Commission proposed
amendments to Rules 17a-5 and 17a-11
and proposed new Form Custody. An
Initial Regulatory Flexibility Analysis
(‘‘IRFA’’) was included in the proposing
release.876 This Final Regulatory
Flexibility Analysis has been prepared
in accordance with the provisions of the
RFA.
A. Need for and Objectives of the
Amendments and New Form
The final rules amend certain brokerdealer annual reporting, audit, and
notification requirements. The
amendments include a requirement that
broker-dealer audits be conducted in
accordance with standards of the
PCAOB, that broker-dealers file either a
compliance report or an exemption
report covered by a report prepared by
an independent public accountant, and
that clearing broker-dealers allow
representatives of the Commission or
the broker-dealer’s DEA to review the
documentation associated with certain
reports of the broker-dealer’s
independent public accountant and to
allow the accountant to discuss its
findings with the representatives when
requested in connection with a
regulatory examination of the brokerVIII. Final Regulatory Flexibility
dealer. The amendments also require a
Analysis
broker-dealer to file a new form with its
DEA that elicits information about the
The Regulatory Flexibility Act
broker-dealer’s practices with respect to
871 requires Federal agencies, in
(‘‘RFA’’)
the custody of securities and funds of
promulgating rules, to consider the
customers and others.
impact of those rules on small entities.
The amendments and new form are
Section 603(a) 872 of the Administrative
designed, among other things, to
Procedure Act,873 as amended by the
RFA, generally requires the Commission provide additional safeguards with
to undertake a regulatory flexibility
respect to broker-dealer custody of
analysis of all proposed rules, or
customer securities and funds, to
proposed rule amendments, to
enhance the ability of the Commission
determine the impact of such
to oversee broker-dealer custody
rulemaking on small entities.874 Section practices, to increase the focus of
605(b) of the RFA provides that this
carrying broker-dealers and their
requirement does not apply to any
independent public accountants on
proposed rule or proposed rule
compliance, and internal control over
amendment, which if adopted, would
compliance, with certain financial and
not ‘‘have a significant economic impact custodial requirements, to facilitate the
ability of the PCAOB to implement the
871 5 U.S.C. 601 et seq.
explicit oversight authority over broker872 5 U.S.C. 603(a).
dealer audits provided to the PCAOB by
873 5 U.S.C. 551 et seq.
the Dodd-Frank Act, and to satisfy the
874 Although section 601(b) of the RFA defines
the term small entity, the statute permits agencies
internal control report requirement in
to formulate their own definitions. The Commission Rule 206(4)–2 for certain broker-dealers
has adopted definitions for the term ‘‘small entity’’
affiliated with, or dually-registered as,
for the purposes of Commission rulemaking in
investment advisers.
accordance with the RFA. Those definitions, as
relevant to this rulemaking, are set forth in Rule 0–
10. See 17 CFR 240.0–10. See Statement of
Management on Internal Accounting Control,
Exchange Act Release No. 18451 (Jan. 28, 1982), 47
FR 5215 (Feb. 4, 1982).
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875 See
876 See
5 U.S.C. 605(b).
Broker-Dealer Reports, 76 FR at 37601–
37602.
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B. Significant Issues Raised by Public
Comments
The Commission requested comment
with regard to matters discussed in the
IRFA, including comments with respect
to the number of small entities that may
be affected by the proposed rule
amendments and whether the effect on
small entities would be economically
significant.877
The Commission did not receive any
comments specifically addressing the
IRFA. However, several commenters
discussed the impact of the proposal on
small broker-dealers. One commenter
stated that the proposed amendments
‘‘place unnecessary regulatory burdens
and costs on the industry, in general,
and smaller firms in particular.’’ 878
Another commenter stated that small
broker-dealers may find the timing of
the transition to be a ‘‘burden,’’ and
requested that the Commission provide
a longer transition period.879 A third
commenter suggested that the
exemption report and the accountant’s
report on the exemption report be
replaced with a ‘‘check box on the
FOCUS report’’ and that with regard to
these reports ‘‘[t]he amount of
paperwork involved for small firms that
do not carry customer securities seems
rather excessive.’’ 880 A fourth
commenter stated that the proposed
transition period may burden smaller
broker-dealers, and suggested that to
facilitate the transition, the Commission
should provide examples of best
practices and deficiencies, with the
cooperation of the AICPA.881 This
commenter also suggested that the
effective date for the annual reporting
requirements should be one year after
publication of the final rule.882
The Commission is sensitive to the
burdens the rule amendments and new
form will have on small broker-dealers.
To remove unnecessary burdens, the
final rule amendments contain certain
modifications from the proposal
designed to alleviate some of the
concerns regarding small brokerdealers.883 The modifications are
discussed in the following paragraphs.
As is discussed above, the
Commission has modified the proposed
877 Id.
at 37602.
IMS Letter.
879 See Citrin Letter.
880 See Angel Letter.
881 See Citrin Letter.
882 Id. The commenter also specifically suggested
that if non-carrying and smaller broker-dealers must
use PCAOB standards, that the Commission should
defer the effective date for one year after the
approval of the amendments. Id.
883 As is discussed below, small broker-dealers
are in most instances not carrying broker-dealers.
See section VIII.C. of this release.
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878 See
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amendments with respect to the
exemption report in a manner that will
likely result in lower costs for small
broker-dealers than would have been
the case if the Commission had adopted
the proposed amendments without the
modifications. In particular, the final
rule provides that a broker-dealer can
file the exemption report if it ‘‘claimed
that it was exempt’’ from Rule 15c3–3
throughout the most recent fiscal year.
This modification from the proposal—
which provided that a broker-dealer
could file the exemption report if the
broker-dealer ‘‘is exempt from Rule
15c3–3’’—is designed to address
concerns raised by commenters that a
non-carrying broker-dealer might be
required to file the compliance report
because of an instance during the year
in which it did not meet the relied on
exemption provision in paragraph (k) of
Rule 15c3–3.884 As discussed in the
economic analysis, the compliance
report costs are significantly greater
than the exemption report costs. The
final rule clarifies that a non-carrying
broker-dealer that has an exception to
meeting the exemption provisions in
paragraph (k) of Rule 15c3–3 need not
file the compliance report; however, the
broker-dealer would be required to
identify, to its best knowledge and
belief, in its exemption report each
exception during the most recent fiscal
year, if applicable, including a brief
description of the exception and the
approximate date on which the
exception existed.
In addition, only clearing brokerdealers will be subject to the
requirements that the Commission is
adopting today that provide
Commission and DEA examination staff
with the ability to review audit
documentation associated with brokerdealers’ annual audit reports and allow
their independent public accountants to
discuss findings relating to the audit
reports with Commission and DEA
examination staff.
To alleviate burdens associated with
Form Custody, the Commission has
modified the form’s instructions to
make clear that questions on the form
that cannot be answered because the
broker-dealer does not engage in a
884 See SIFMA Letter. As discussed above in
section II.B.1. of this release, there will be cases
where a broker-dealer changes its business model
to convert from a carrying broker-dealer to a noncarrying broker-dealer during the fiscal year. In this
case, the broker-dealer could seek exemptive relief
under section 36 of the Exchange Act (15 U.S.C.
78mm) from the requirement to file the compliance
report and to instead file the exemption report. In
analyzing such a request, the period of time the
broker-dealer operated as a carrying broker-dealer
would be a relevant consideration.
PO 00000
Frm 00078
Fmt 4701
Sfmt 4700
particular activity do not need to be
answered.
In response to comments, the
Commission also has delayed the
effective dates associated with the
proposed reporting and attestation
amendments, which will provide all
broker-dealers, including smaller
broker-dealers, with a longer transition
period to prepare for the new
requirements.
As is discussed above, the
Commission considered the comment
that it should replace the exemption
report with a box to check on the
FOCUS Report as the amount of
paperwork for small firms ‘‘seems rather
excessive.’’ 885 After careful
consideration of this and other
alternatives, the Commission
determined that of the alternatives
considered, none are appropriate
alternatives to the exemption report.
Requiring the broker-dealer to (1) create
a separate written report stating that it
is claiming the exemption and
identifying the basis for the exemption,
including any identified exceptions in
meeting the conditions set forth in
§ 240.15c3–3(k) and (2) file this report
with the Commission and the brokerdealer’s DEA should increase brokerdealers’ focus on the accuracy of its
compliance with the statements being
made because of the potential for
liability for false statements, enhance
compliance with the exemption
conditions in Rule 15c3–3, and
therefore provide better protection of
customer assets.
Finally, with respect to the comment
that the Commission should provide
examples of best practices and
deficiencies with the cooperation of the
AICPA, the Commission notes that the
question of whether further guidance is
necessary is best answered after the
requirements become effective and
practical compliance questions arise. In
addition, the Commission will publish a
Small Entity Compliance Guide relating
to these amendments.
C. Small Entities Subject to the Rules
Paragraph (c) of Rule 0–10 provides
that, for purposes of the RFA, a small
entity when used with reference to a
broker-dealer (‘‘small broker-dealer’’)
means a broker-dealer that: (1) Had total
capital (net worth plus subordinated
liabilities) of less than $500,000 on the
date in the prior fiscal year as of which
its audited financial statements were
prepared pursuant to Rule 17a–5(d) or,
if not required to file such statements,
a broker-dealer that had total capital
(net worth plus subordinated liabilities)
885 See
E:\FR\FM\21AUR3.SGM
section II.B.4.iii. of this release.
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
of less than $500,000 on the last
business day of the preceding fiscal year
(or in the time that it has been in
business if shorter); and (2) is not
affiliated with any person (other than a
natural person) that is not a small
business or small organization.886 Based
on December 31, 2011 FOCUS Report
data, the Commission estimates that
there are approximately 812 brokerdealers that are classified as ‘‘small’’
entities for purposes of the RFA. Of
these, the Commission estimates that
there are approximately eight brokerdealers that are carrying broker-dealers.
The Commission estimated for purposes
of the IRFA that there were
approximately 871 broker-dealers that
were classified as small entities for
purposes of the RFA and that there were
no broker-dealers that were carrying
firms that satisfied the definition of a
small broker-dealer.887
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D. Reporting, Recordkeeping, and Other
Compliance Requirements
The Commission’s amendments to
Rule 17a–5 retain the current
requirement that broker-dealers
annually file financial statements and
supporting schedules (‘‘financial
report’’) that must be audited by a
PCAOB-registered accountant. Under
the amendments, the financial report
must be audited in accordance with
standards of the PCAOB, instead of in
accordance with GAAS, as previously
required.
In addition to the financial report, the
amendments require broker-dealers to
file one of two new reports: either a
compliance report or an exemption
report. If a broker-dealer did not claim
that it was exempt from Rule 15c3–3
throughout the most recent fiscal year,
the broker-dealer must prepare and file
with the Commission a compliance
report containing certain statements
regarding the broker-dealer’s internal
control over compliance with the
financial responsibility rules and
compliance with certain of those rules.
Alternatively, if the broker-dealer
claimed that it was exempt from Rule
15c3–3 throughout the most recent
fiscal year, the broker-dealer must
prepare and file with the Commission
an exemption report containing a
statement that it claimed that it was
exempt from Rule 15c3–3 during that
period and identify the provisions
886 17
CFR 240.0–10(c).
Broker-Dealer Reports, 76 FR at 37602.
Although the Commission received no comments
regarding the its initial estimate that there were no
small carrying broker-dealers, the estimate is
nonetheless being revised based on additional
analysis of available information.
887 See
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17:14 Aug 20, 2013
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under which it claimed that it was
exempt from Rule 15c3–3.
The amendments to Rule 17a–5 also
eliminate the ‘‘material inadequacy’’
concept and, among other things,
replace the requirement that the brokerdealer’s independent public accountant
prepare, and the broker-dealer file with
the Commission, a material inadequacy
report with a requirement for the
accountant to prepare a new report
covering either the compliance report or
the exemption report, as applicable. If
the broker-dealer is a carrying brokerdealer, the accountant must prepare a
report based on an examination, in
accordance with PCAOB standards, of
certain statements by the broker-dealer
in the compliance report. If the brokerdealer claimed an exemption from Rule
15c3–3, the accountant must prepare a
report based on a review, in accordance
with PCAOB standards, of the
exemption report. Broker-dealers must
file these reports of the accountant with
the Commission along with the financial
report and either the compliance report
or the exemption report.
Together, the financial report and the
compliance report or the exemption
report and the accountant’s reports
covering those reports comprise the
annual reports that the broker-dealer
must file each fiscal year with the
Commission and the broker-dealer’s
DEA. The amendments require that the
broker-dealer also file the annual reports
with SIPC if the broker-dealer is a
member of SIPC.
Amendments to Rule 17a–5 also
require that if, during the course of an
audit, a broker-dealer’s independent
public accountant determines that the
broker-dealer is not in compliance with
the financial responsibility rules, or that
any material weaknesses exist, the
accountant must immediately notify the
broker-dealer. The broker-dealer must
notify the Commission and its DEA of
the material weakness and must notify
the Commission and the DEA of the
non-compliance if that non-compliance
would otherwise trigger a notification
requirement.
Amendments to Rule 17a–11 require
that when a broker-dealer discovers, or
is notified by its independent public
accountant, of the existence of any
material weakness under Rule 17a–5,
the broker-dealer must notify the
Commission and transmit a report to the
Commission stating what the brokerdealer has done or is doing to correct
the situation. The amendments
substituted the term material weakness
for the term material inadequacy with
regard to Rule 17a–5.
Under the amendments, carrying
broker-dealers or those that clear
PO 00000
Frm 00079
Fmt 4701
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51987
transactions must agree to allow
Commission or DEA examination staff,
if requested in writing for purposes of
an examination of the broker-dealer, to
review ‘‘the documentation associated
with the reports of the accountant’’ and
to discuss the accountant’s findings
with the accountant.
The amendments require brokerdealers to file a new ‘‘Form Custody’’
each quarter to elicit information
concerning whether a broker-dealer
maintains custody of customer and noncustomer assets, and, if so, how such
assets are maintained. Form Custody
must be filed with the broker-dealer’s
DEA. The DEA must transmit the
information obtained from Form
Custody to the Commission at the same
time that it transmits FOCUS Report
data to the Commission under
paragraph (a)(4) of Rule 17a–5.
The impact of the amendments on
small broker-dealers will be
substantially less than on larger firms.
Most small broker-dealers are exempt
from Rule 15c3–3 and therefore must
file the exemption report. As discussed
above, the exemption report must be
reviewed by the independent public
accountant, in lieu of the compliance
report, which must be examined by the
accountant. In addition, Form Custody
would elicit less information from
broker-dealers that do not maintain
custody of customer assets, and
therefore the form should be less
burdensome for these broker-dealers.
E. Agency Action To Minimize Effect on
Small Entities
Pursuant to section 3(a) of the RFA,888
the Commission must consider
significant alternatives that would
accomplish the Commission’s stated
objectives, while minimizing any
significant adverse impact on small
entities. In connection with the final
rules, the Commission considered the
following alternatives: (1) Establishing
differing compliance or reporting
requirements or timetables that take into
account the resources available to
smaller entities; (2) clarifying,
consolidating, or simplifying
compliance and reporting requirements
for smaller entities; (3) the use of
performance standards rather than
design standards; and (4) exempting
smaller entities from coverage of the
rules, or any part of the rules.
The Commission considered differing
compliance and reporting requirements
and timetables in adopting the
amendments discussed in this release,
which took into account the resources
available to smaller entities. For
888 5
E:\FR\FM\21AUR3.SGM
U.S.C. 603(c).
21AUR3
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51988
Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
example, as is discussed above, the
Commission considered alternatives to
the exemption report requirements,
which resulted in modifications to the
final rule that make clear that brokerdealers claiming exemptions from Rule
15c3–3 will remain subject to those
requirements even if certain exceptions
arise.889 This reduces the burden on
small broker-dealers that would
otherwise be subject to the more
resource-intensive compliance and
examination report requirements
applicable to carrying broker-dealers.
In addition, the Commission, in
establishing effective dates for these
amendments, considered the resources
available to small broker-dealers. In this
regard, the Commission is delaying the
effective dates for the audit and
reporting requirements, which will
provide small broker-dealers with
greater flexibility in allocating their
resources while preparing to comply
with applicable amendments.
The Commission also clarified,
consolidated, and simplified
compliance and reporting requirements
for broker-dealers in connection with
the amendments. As discussed above,
the Commission clarified and simplified
requirements applicable to Form
Custody by specifying in the final form
that broker-dealers are not required to
answer questions that do not apply to
their business activities. Further, in
terms of consolidating regulatory
requirements applicable to brokerdealers, a broker-dealer affiliated with,
or dually-registered as, an investment
adviser that is subject to the compliance
report requirement can use the
independent public accountant’s
examination of the compliance report to
satisfy reporting obligations under
Advisers Act Rule 206(4)–2.
The Commission generally used
design standards rather than
performance standards in connection
with the final rule amendments because
the Commission believes design
standards will better accomplish its
objectives of enhancing safeguards with
respect to broker-dealer custody of
securities and funds. The specific
disclosure requirements in the final rule
will promote comparable and consistent
types of disclosures by broker-dealers,
which will facilitate the ability of
Commission and DEA staff to assess
broker-dealer compliance with
applicable requirements.
The Commission also considered, and
is adopting, amendments that exempt
certain types of broker-dealers from
certain requirements. For example,
889 See sections II.B.4.iii. and VII.C.1.ii.b. of this
release.
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17:14 Aug 20, 2013
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broker-dealers that are not clearing
broker-dealers, which include most
small broker-dealers, do not need to
comply with the access to accountant
and audit documentation amendments.
Most small broker-dealers also will not
be subject to the new compliance and
examination report requirements, as
small broker-dealers are in most
instances not carrying broker-dealers.
In addition, if the Commission
subsequently determines that it is
appropriate to exempt a broker-dealer,
or type of broker-dealer, from such
requirements, the Commission has
existing authority under which it can
act. In particular, under Exchange Act
section 36, the Commission, by rule,
regulation, or order, may exempt any
person, or any class or classes of
persons, from any rule under the
Exchange Act to the extent that such
exemption is necessary or appropriate
in the public interest and is consistent
with the protection of investors.890
IX. Statutory Authority
The Commission is amending Rule
17a–5 and Rule 17a–11 under the
Exchange Act (17 CFR 240.17a–5 and 17
CFR 240.17a–11) and adopting new
Form Custody (17 CFR 249.639)
pursuant to the authority conferred by
the Exchange Act, including sections 15,
17, 23(a) and 36.891
List of Subjects in 17 CFR Parts 240 and
249
Brokers, Confidential business
information, Fraud, Reporting and
recordkeeping requirements, Securities.
Text of the Amendments
For the reasons set out in the
preamble, the Commission is amending
Title 17, Chapter II, of the Code of
Federal Regulations as follows:
PART 240—GENERAL RULES AND
REGULATIONS, SECURITIES
EXCHANGE ACT OF 1934
1. The authority citation for part 240
continues to read, in part, as follows:
■
Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn,
77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f,
78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m,
78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q,
78q–1, 78s, 78u–5, 78w, 78x, 78ll, 78mm,
80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–
4, 80b–11, 7201 et seq., and 8302; 7 U.S.C.
2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C.
1350; and Pub. L. 111–203, 939A, 124 Stat.
1376, (2010), unless otherwise noted.
*
■
*
*
*
*
2. Section 240.17a–5 is amended by:
890 15
891 15
PO 00000
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U.S.C. 78o, 78q, 78w(a) and 78mm.
Frm 00080
Fmt 4701
Sfmt 4700
a. In paragraph (a)(2)(i), adding the
word ‘‘transactions’’ after the word
‘‘clears’’ and removing the words ‘‘shall
file’’ and adding in their place ‘‘must
file with the Commission.’’
■ b. In paragraph (a)(2)(ii), removing the
words ‘‘shall file’’ and adding in their
place ‘‘must file with the Commission’’
and removing the phrase ‘‘date selected
for the annual audit of financial
statements where said date is other than
a calendar quarter’’ and adding in its
place ‘‘end of the fiscal year of the
broker or dealer where that date is not
the end of a calendar quarter.’’;
■ c. In paragraph (a)(2)(iii), removing
the phrase ‘‘who does not carry nor
clear transactions nor carry customer
accounts shall file’’ and adding in its
place ‘‘that neither clears transactions
nor carries customer accounts must file
with the Commission’’ and removing
the phrase ‘‘date selected for the annual
audit of financial statements where said
date is other than the end of the
calendar quarter.’’ and adding in its
place ‘‘end of the fiscal year of the
broker or dealer where that date is not
the end of a calendar quarter.’’;
■ d. In paragraph (a)(2)(iv), removing
the words ‘‘shall file’’ and adding in
their place ‘‘must file with the
Commission’’ and adding the phrase
‘‘(‘‘designated examining authority’’)’’
after the phrase ‘‘section 17(d) of the
Act’’;
■ e. In paragraph (a)(3), in the first
sentence, adding the words ‘‘that must
be filed with the Commission’’ after the
words ‘‘provided for in this paragraph
(a)’’;
■ f. Redesignating paragraphs (a)(5) and
(6) as paragraphs (a)(6) and (7);
■ g. In newly redesignated paragraph
(a)(6)(ii)(A), removing the phrase
‘‘(a)(5)(i)’’ and adding in its place
‘‘(a)(6)(i)’’;
■ h. Adding new paragraph (a)(5);
■ i. Revising paragraph (b)(2);
■ j. In paragraph (b)(4), removing the
word ‘‘he’’ and adding in its place ‘‘the
broker or dealer’’.
■ k. Removing paragraph (b)(6);
■ l. In paragraph (c)(1)(i), removing the
phrase ‘‘his customers’’ and adding in
its place ‘‘customers of the introducing
broker or dealer’’;
■ m. In paragraph (c)(1)(iii), removing
the phrase ‘‘in the manner contemplated
by the $2,500 minimum net capital
requirement of § 240.15c3–1’’ and
adding in its place ‘‘and otherwise
qualified to maintain net capital of no
less than what is required under
§ 240.15c3–1(a)(2)(iv)’’;
■ n. In paragraph (c)(2) introductory
text, in the first sentence, removing the
phrase ‘‘date of the audited financial
statements required by paragraph (d) of
■
E:\FR\FM\21AUR3.SGM
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
this section’’ and adding in its place
‘‘end of the fiscal year of the broker or
dealer’’;
■ o. In paragraph (c)(2)(i) removing the
phrase ‘‘balance sheet with appropriate
notes prepared in accordance with’’ and
adding in its place ‘‘Statement of
Financial Condition with appropriate
notes prepared in accordance with
U.S.’’;
■ p. Removing paragraph (c)(2)(iii);
■ q. Redesignating paragraph (c)(2)(iv)
as (c)(2)(iii);
■ r. In newly redesignated paragraph
(c)(2)(iii), removing the phrase ‘‘annual
audit report of the broker or dealer
pursuant to § 240.17a-5’’ and adding in
its place ‘‘financial report of the broker
or dealer under paragraph (d)(1)(i)(A) of
this section’’ and adding at the end the
word ‘‘and’’;
■ s. Adding new paragraph (c)(2)(iv);
■ t. In paragraph (c)(4) introductory text
removing the word ‘‘‘customer’’’ and
adding in its place ‘‘customer’’;
■ u. In paragraphs (c)(5)(ii)(A) and
(c)(5)(iii) introductory text, removing
the phrases ‘‘Web site’’ and ‘‘Web sites’’
and adding in their place ‘‘website’’ and
‘‘websites’’;
■ v. Removing paragraph (c)(5)(vi);
■ w. Revising paragraph (d);
■ x. In paragraph (e) introductory text,
removing the phrase ‘‘financial
statements’’ and adding in its place
‘‘annual reports’’ and removing the
word ‘‘shall’’ and adding in its place
‘‘must’’;
■ y. Revising paragraphs (e)(1) through
(4);
■ z. Removing paragraph (e)(5);
■ aa. Revising paragraphs (f) through (i);
■ bb. Removing and reserving paragraph
(j);
■ cc. In paragraph (m)(1), removing the
word ‘‘audit’’ after the word ‘‘annual’’;
and
■ dd. In paragraph (n)(2) removing the
phrase ‘‘audit report’’ and adding in its
place ‘‘annual reports’’; adding the
phrase ‘‘in writing’’ after the word
‘‘approved’’ and removing the phrase
‘‘pursuant to paragraph (d)(1)(i) of this
section’’ and adding in its place ‘‘of the
broker or dealer’’.
The revisions and additions read as
follows:
mstockstill on DSK4VPTVN1PROD with RULES3
§ 240.17a–5 Reports to be made by certain
brokers and dealers.
(a) * * *
(5) Every broker or dealer subject to
this paragraph (a) must file Form
Custody (§ 249.639 of this chapter) with
its designated examining authority
within 17 business days after the end of
each calendar quarter and within 17
business days after the end of the fiscal
year of the broker or dealer where that
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17:14 Aug 20, 2013
Jkt 229001
date is not the end of a calendar quarter.
The designated examining authority
must maintain the information obtained
through the filing of Form Custody and
transmit the information to the
Commission, at such time as it transmits
the applicable part of Form X–17A–5
(§ 249.617 of this chapter) as required in
paragraph (a)(4) of this section.
*
*
*
*
*
(b) * * *
(2) The broker or dealer must attach
to the report required by paragraph
(b)(1) of this section an oath or
affirmation that to the best knowledge
and belief of the person making the oath
or affirmation the information contained
in the report is true and correct. The
oath or affirmation must be made before
a person duly authorized to administer
such oaths or affirmations. If the broker
or dealer is a sole proprietorship, the
oath or affirmation must be made by the
proprietor; if a partnership, by a general
partner; if a corporation, by a duly
authorized officer; or if a limited
liability company or limited liability
partnership, by the chief executive
officer, chief financial officer, manager,
managing member, or those members
vested with management authority for
the limited liability company or limited
liability partnership.
*
*
*
*
*
(c) * * *
(2) * * *
(iv) If, in connection with the most
recent annual reports required under
paragraph (d) of this section, the report
of the independent public accountant
required under paragraph (d)(1)(i)(C) of
this section covering the report of the
broker or dealer required under
paragraph (d)(1)(i)(B)(1) of this section
identifies one or more material
weaknesses, a statement by the broker or
dealer that one or more material
weaknesses have been identified and
that a copy of the report of the
independent public accountant required
under paragraph (d)(1)(i)(C) of this
section is currently available for the
customer’s inspection at the principal
office of the Commission in
Washington, DC, and the regional office
of the Commission for the region in
which the broker or dealer has its
principal place of business.
*
*
*
*
*
(d) Annual reports. (1)(i) Except as
provided in paragraphs (d)(1)(iii) and
(d)(1)(iv) of this section, every broker or
dealer registered under section 15 of the
Act must file annually:
(A) A financial report as described in
paragraph (d)(2) of this section; and
(B)(1) If the broker or dealer did not
claim it was exempt from § 240.15c3–3
PO 00000
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51989
throughout the most recent fiscal year,
a compliance report as described in
paragraph (d)(3) of this section executed
by the person who makes the oath or
affirmation under paragraph (e)(2) of
this section; or
(2) If the broker or dealer did claim
that it was exempt from § 240.15c3–3
throughout the most recent fiscal year,
an exemption report as described in
paragraph (d)(4) of this section executed
by the person who makes the oath or
affirmation under paragraph (e)(2) of
this section;
(C) Except as provided in paragraph
(e)(1)(i) of this section, a report prepared
by an independent public accountant,
under the engagement provisions in
paragraph (g) of this section, covering
each report required to be filed under
paragraphs (d)(1)(i)(A) and (B) of this
section.
(ii) The reports required to be filed
under this paragraph (d) must be as of
the same fiscal year end each year,
unless a change is approved in writing
by the designated examining authority
for the broker or dealer under paragraph
(n) of this section. A copy of the written
approval must be sent to the
Commission’s principal office in
Washington, DC, and the regional office
of the Commission for the region in
which the broker or dealer has its
principal place of business.
(iii) A broker or dealer succeeding to
and continuing the business of another
broker or dealer need not file the reports
under this paragraph (d) as of a date in
the fiscal year in which the succession
occurs if the predecessor broker or
dealer has filed reports in compliance
with this paragraph (d) as of a date in
such fiscal year.
(iv) A broker or dealer that is a
member of a national securities
exchange, has transacted a business in
securities solely with or for other
members of a national securities
exchange, and has not carried any
margin account, credit balance, or
security for any person who is defined
as a customer in paragraph (c)(4) of this
section, is not required to file reports
under this paragraph (d).
(2) Financial report. The financial
report must contain:
(i) A Statement of Financial
Condition, a Statement of Income, a
Statement of Cash Flows, a Statement of
Changes in Stockholders’ or Partners’ or
Sole Proprietor’s Equity, and a
Statement of Changes in Liabilities
Subordinated to Claims of General
Creditors. The statements must be
prepared in accordance with U.S.
generally accepted accounting
principles and must be in a format that
is consistent with the statements
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contained in Form X–17A–5 (§ 249.617
of this chapter) Part II or Part IIA. If the
Statement of Financial Condition filed
in accordance with instructions to Form
X–17A–5, Part II or Part IIA, is not
consolidated, a summary of financial
data, including the assets, liabilities,
and net worth or stockholders’ equity,
for subsidiaries not consolidated in the
Part II or Part IIA Statement of Financial
Condition as filed by the broker or
dealer must be included in the notes to
the financial statements reported on by
the independent public accountant.
(ii) Supporting schedules that
include, from Part II or Part IIA of Form
X–17A–5 (§ 249.617 of this chapter), a
Computation of Net Capital Under
§ 240.15c3–1, a Computation for
Determination of the Reserve
Requirements under Exhibit A of
§ 240.15c3–3, and Information Relating
to the Possession or Control
Requirements Under § 240.15c3–3.
(iii) If either the Computation of Net
Capital under § 240.15c3–1 or the
Computation for Determination of the
Reserve Requirements Under Exhibit A
of § 240.15c3–3 in the financial report is
materially different from the
corresponding computation in the most
recent Part II or Part IIA of Form X–
17A–5 (§ 249.617 of this chapter) filed
by the broker or dealer pursuant to
paragraph (a) of this section, a
reconciliation, including appropriate
explanations, between the computation
in the financial report and the
computation in the most recent Part II
or Part IIA of Form X–17A–5 filed by
the broker or dealer. If no material
differences exist, a statement so
indicating must be included in the
financial report.
(3) Compliance report. (i) The
compliance report must contain:
(A) Statements as to whether:
(1) The broker or dealer has
established and maintained Internal
Control Over Compliance as that term is
defined in paragraph (d)(3)(ii) of this
section;
(2) The Internal Control Over
Compliance of the broker or dealer was
effective during the most recent fiscal
year;
(3) The Internal Control Over
Compliance of the broker or dealer was
effective as of the end of the most recent
fiscal year;
(4) The broker or dealer was in
compliance with §§ 240.15c3–1 and
240.15c3–3(e) as of the end of the most
recent fiscal year; and
(5) The information the broker or
dealer used to state whether it was in
compliance with §§ 240.15c3–1 and
240.15c3–3(e) was derived from the
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books and records of the broker or
dealer.
(B) If applicable, a description of each
material weakness in the Internal
Control Over Compliance of the broker
or dealer during the most recent fiscal
year.
(C) If applicable, a description of any
instance of non-compliance with
§§ 240.15c3–1 or 240.15c3–3(e) as of the
end of the most recent fiscal year.
(ii) The term Internal Control Over
Compliance means internal controls that
have the objective of providing the
broker or dealer with reasonable
assurance that non-compliance with
§ 240.15c3–1, § 240.15c3–3, § 240.17a–
13, or any rule of the designated
examining authority of the broker or
dealer that requires account statements
to be sent to the customers of the broker
or dealer (an ‘‘Account Statement Rule’’)
will be prevented or detected on a
timely basis.
(iii) The broker or dealer is not
permitted to conclude that its Internal
Control Over Compliance was effective
during the most recent fiscal year if
there were one or more material
weaknesses in its Internal Control Over
Compliance during the most recent
fiscal year. The broker or dealer is not
permitted to conclude that its Internal
Control Over Compliance was effective
as of the end of the most recent fiscal
year if there were one or more material
weaknesses in its internal control as of
the end of the most recent fiscal year. A
material weakness is a deficiency, or a
combination of deficiencies, in Internal
Control Over Compliance such that
there is a reasonable possibility that
non-compliance with §§ 240.15c3–1 or
240.15c3–3(e) will not be prevented or
detected on a timely basis or that noncompliance to a material extent with
§ 240.15c3–3, except for paragraph (e),
§ 240.17a–13, or any Account Statement
Rule will not be prevented or detected
on a timely basis. A deficiency in
Internal Control Over Compliance exists
when the design or operation of a
control does not allow the management
or employees of the broker or dealer, in
the normal course of performing their
assigned functions, to prevent or detect
on a timely basis non-compliance with
§ 240.15c3–1, § 240.15c3–3, § 240.17a–
13, or any Account Statement Rule.
(4) Exemption report. The exemption
report must contain the following
statements made to the best knowledge
and belief of the broker or dealer:
(i) A statement that identifies the
provisions in § 240.15c3–3(k) under
which the broker or dealer claimed an
exemption from § 240.15c3–3;
(ii) A statement that the broker or
dealer met the identified exemption
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provisions in § 240.15c3–3(k)
throughout the most recent fiscal year
without exception or that it met the
identified exemption provisions in
§ 240.15c3–3(k) throughout the most
recent fiscal year except as described
under paragraph (d)(4)(iii) of this
section; and
(iii) If applicable, a statement that
identifies each exception during the
most recent fiscal year in meeting the
identified exemption provisions in
§ 240.15c3–3(k) and that briefly
describes the nature of each exception
and the approximate date(s) on which
the exception existed.
(5) The annual reports must be filed
not more than sixty (60) calendar days
after the end of the fiscal year of the
broker or dealer.
(6) The annual reports must be filed
at the regional office of the Commission
for the region in which the broker or
dealer has its principal place of
business, the Commission’s principal
office in Washington, DC, the principal
office of the designated examining
authority for the broker or dealer, and
with the Securities Investor Protection
Corporation (‘‘SIPC’’) if the broker or
dealer is a member of SIPC. Copies of
the reports must be provided to all selfregulatory organizations of which the
broker or dealer is a member, unless the
self-regulatory organization by rule
waives this requirement.
(e) * * *
(1)(i) The broker or dealer is not
required to engage an independent
public accountant to provide the reports
required under paragraph (d)(1)(i)(C) of
this section if, since the date of the
registration of the broker or dealer under
section 15 of the Act (15 U.S.C. 78o) or
of the previous annual reports filed
under paragraph (d) of this section:
(A) The securities business of the
broker or dealer has been limited to
acting as broker (agent) for the issuer in
soliciting subscriptions for securities of
the issuer, the broker has promptly
transmitted to the issuer all funds and
promptly delivered to the subscriber all
securities received in connection with
the transaction, and the broker has not
otherwise held funds or securities for or
owed money or securities to customers;
or
(B) The securities business of the
broker or dealer has been limited to
buying and selling evidences of
indebtedness secured by mortgage, deed
of trust, or other lien upon real estate or
leasehold interests, and the broker or
dealer has not carried any margin
account, credit balance, or security for
any securities customer.
(ii) A broker or dealer that files annual
reports under paragraph (d) of this
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section that are not covered by reports
prepared by an independent public
accountant must include in the oath or
affirmation required by paragraph (e)(2)
of this section a statement of the facts
and circumstances relied upon as a
basis for exemption from the
requirement that the annual reports
filed under paragraph (d) of this section
be covered by reports prepared by an
independent public accountant.
(2) The broker or dealer must attach
to the financial report an oath or
affirmation that, to the best knowledge
and belief of the person making the oath
or affirmation,
(i) The financial report is true and
correct; and
(ii) Neither the broker or dealer, nor
any partner, officer, director, or
equivalent person, as the case may be,
has any proprietary interest in any
account classified solely as that of a
customer.
The oath or affirmation must be made
before a person duly authorized to
administer such oaths or affirmations. If
the broker or dealer is a sole
proprietorship, the oath or affirmation
must be made by the proprietor; if a
partnership, by a general partner; if a
corporation, by a duly authorized
officer; or if a limited liability company
or limited liability partnership, by the
chief executive officer, chief financial
officer, manager, managing member, or
those members vested with management
authority for the limited liability
company or limited liability
partnership.
*
*
*
*
*
(3) The annual reports filed under
paragraph (d) of this section are not
confidential, except that, if the
Statement of Financial Condition in a
format that is consistent with Form X–
17A–5 (§ 249.617 of this chapter), Part
II, or Part IIA, is bound separately from
the balance of the annual reports filed
under paragraph (d) of this section, and
each page of the balance of the annual
reports is stamped ‘‘confidential,’’ then
the balance of the annual reports shall
be deemed confidential to the extent
permitted by law. However, the annual
reports, including the confidential
portions, will be available for official
use by any official or employee of the
U.S. or any State, by national securities
exchanges and registered national
securities associations of which the
broker or dealer filing such a report is
a member, by the Public Company
Accounting Oversight Board, and by any
other person if the Commission
authorizes disclosure of the annual
reports to that person as being in the
public interest. Nothing contained in
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this paragraph may be construed to be
in derogation of the rules of any
registered national securities association
or national securities exchange that give
to customers of a member broker or
dealer the right, upon request to the
member broker or dealer, to obtain
information relative to its financial
condition.
(4)(i) The broker or dealer must file
with SIPC a report on the SIPC annual
general assessment reconciliation or
exclusion from membership forms that
contains such information and is in
such format as determined by SIPC by
rule and approved by the Commission.
(ii) Until the earlier of two years after
the date paragraph (e)(4)(i) of this
section is effective or SIPC adopts a rule
under paragraph (e)(4)(i) of this section
and the rule is approved by the
Commission, the broker or dealer must
file with SIPC a supplemental report on
the status of the membership of the
broker or dealer in SIPC if, under
paragraph (d)(1)(i)(C) of this section, the
broker or dealer is required to file
reports prepared by an independent
public accountant. The supplemental
report must include the independent
public accountant’s report on applying
agreed-upon procedures based on the
performance of the procedures
enumerated in paragraph (e)(4)(ii)(C) of
this section. The supplemental report
must cover the SIPC annual general
assessment reconciliation or exclusion
from membership forms not previously
reported on under this paragraph (e)(4)
that were required to be filed on or prior
to the date of the annual reports
required by paragraph (d) of this
section: Provided, that the broker or
dealer is not required to file the
supplemental report on the SIPC annual
general assessment reconciliation or
exclusion from membership form for
any period during which the SIPC
assessment is a specified dollar value as
provided for in section 4(d)(1)(c) of the
Securities Investor Protection Act of
1970, as amended. The supplemental
report must be filed with the regional
office of the Commission for the region
in which the broker or dealer has its
principal place of business, the
Commission’s principal office in
Washington, DC, the principal office of
the designated examining authority for
the broker or dealer, and the principal
office of SIPC. The supplemental report
must include the following:
(A) A schedule of assessment
payments showing any overpayments
applied and overpayments carried
forward including: payment dates,
amounts, and name of SIPC collection
agent to whom mailed; or
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51991
(B) If exclusion from membership was
claimed, a statement that the broker or
dealer qualified for exclusion from
membership under the Securities
Investor Protection Act of 1970, as
amended; and
(C) An independent public
accountant’s report. The independent
public accountant must be engaged to
perform the following procedures:
(1) Comparison of listed assessment
payments with respective cash
disbursements record entries;
(2) For all or any portion of a fiscal
year, comparison of amounts reflected
in the annual reports required by
paragraph (d) of this section with
amounts reported in the Annual General
Assessment Reconciliation (Form SIPC–
7);
(3) Comparison of adjustments
reported in Form SIPC–7 with
supporting schedules and working
papers supporting the adjustments;
(4) Proof of the arithmetical accuracy
of the calculations reflected in Form
SIPC–7 and in the schedules and
working papers supporting any
adjustments; and
(5) Comparison of the amount of any
overpayment applied with the Form
SIPC–7 on which it was computed; or
(6) If exclusion from membership is
claimed, a comparison of the income or
loss reported in the financial report
required by paragraph (d)(2) of this
section with the Certification of
Exclusion from Membership (Form
SIPC–3).
(f)(1) Qualifications of independent
public accountant. The independent
public accountant must be qualified and
independent in accordance with
§ 210.2–01 of this chapter and the
independent public accountant must be
registered with the Public Company
Accounting Oversight Board if required
by the Sarbanes-Oxley Act of 2002.
(2) Statement regarding independent
public accountant. (i) Every broker or
dealer that is required to file annual
reports under paragraph (d) of this
section must file no later than December
10 of each year (or 30 calendar days
after the effective date of its registration
as a broker or dealer, if earlier) a
statement as prescribed in paragraph
(f)(2)(ii) of this section with the
Commission’s principal office in
Washington, DC, the regional office of
the Commission for the region in which
its principal place of business is located,
and the principal office of the
designated examining authority for the
broker or dealer. The statement must be
dated no later than December 1 (or 20
calendar days after the effective date of
its registration as a broker or dealer, if
earlier). If the engagement of an
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
independent public accountant is of a
continuing nature, providing for
successive engagements, no further
filing is required. If the engagement is
for a single year, or if the most recent
engagement has been terminated or
amended, a new statement must be filed
by the required date.
(ii) The statement must be headed
‘‘Statement regarding independent
public accountant under Rule 17a–
5(f)(2)’’ and must contain the following
information and representations:
(A) Name, address, telephone number,
and registration number of the broker or
dealer.
(B) Name, address, and telephone
number of the independent public
accountant.
(C) The date of the fiscal year of the
annual reports of the broker or dealer
covered by the engagement.
(D) Whether the engagement is for a
single year or is of a continuing nature.
(E) A representation that the
independent public accountant has
undertaken the items enumerated in
paragraphs (g)(1) and (2) of this section.
(F) Except as provided in paragraph
(f)(2)(iii) of this section, a representation
that the broker or dealer agrees to allow
representatives of the Commission or its
designated examining authority, if
requested in writing for purposes of an
examination of the broker or dealer, to
review the audit documentation
associated with the reports of the
independent public accountant filed
under paragraph (d)(1)(i)(C) of this
section. For purposes of this paragraph,
‘‘audit documentation’’ has the meaning
provided in standards of the Public
Company Accounting Oversight Board.
The Commission anticipates that, if
requested, it will accord confidential
treatment to all documents it may obtain
from an independent public accountant
under this paragraph to the extent
permitted by law.
(G) Except as provided in paragraph
(f)(2)(iii) of this section, a representation
that the broker or dealer agrees to allow
the independent public accountant to
discuss with representatives of the
Commission and its designated
examining authority, if requested in
writing for purposes of an examination
of the broker or dealer, the findings
associated with the reports of the
independent public accountant filed
under paragraph (d)(1)(i)(C) of this
section.
(iii) If a broker or dealer neither clears
transactions nor carries customer
accounts, the broker or dealer is not
required to include the representations
in paragraphs (f)(2)(ii)(F) and (G) of this
section.
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(iv) Any broker or dealer that is not
required to file reports prepared by an
independent public accountant under
paragraph (d)(1)(i)(C) of this section
must file a statement required under
paragraph (f)(2)(i) of this section
indicating the date as of which the
unaudited reports will be prepared.
(3) Replacement of accountant. A
broker or dealer must file a notice that
must be received by the Commission’s
principal office in Washington, DC, the
regional office of the Commission for
the region in which its principal place
of business is located, and the principal
office of the designated examining
authority for the broker or dealer not
more than 15 business days after:
(i) The broker or dealer has notified
the independent public accountant that
provided the reports the broker or dealer
filed under paragraph (d)(1)(i)(C) of this
section for the most recent fiscal year
that the independent public
accountant’s services will not be used in
future engagements; or
(ii) The broker or dealer has notified
an independent public accountant that
was engaged to provide the reports
required under paragraph (d)(1)(i)(C) of
this section that the engagement has
been terminated; or
(iii) An independent public
accountant has notified the broker or
dealer that the independent public
accountant would not continue under
an engagement to provide the reports
required under paragraph (d)(1)(i)(C) of
this section; or
(iv) A new independent public
accountant has been engaged to provide
the reports required under paragraph
(d)(1)(i)(C) of this section without any
notice of termination having been given
to or by the previously engaged
independent public accountant.
(v) The notice must include:
(A) The date of notification of the
termination of the engagement or of the
engagement of the new independent
public accountant, as applicable; and
(B) The details of any issues arising
during the 24 months (or the period of
the engagement, if less than 24 months)
preceding the termination or new
engagement relating to any matter of
accounting principles or practices,
financial statement disclosure, auditing
scope or procedure, or compliance with
applicable rules of the Commission,
which issues, if not resolved to the
satisfaction of the former independent
public accountant, would have caused
the independent public accountant to
make reference to them in the report of
the independent public accountant. The
issues required to be reported include
both those resolved to the former
independent public accountant’s
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satisfaction and those not resolved to
the former accountant’s satisfaction.
Issues contemplated by this section are
those that occur at the decision-making
level—that is, between principal
financial officers of the broker or dealer
and personnel of the accounting firm
responsible for rendering its report. The
notice must also state whether the
accountant’s report filed under
paragraph (d)(1)(i)(C) of this section for
any of the past two fiscal years
contained an adverse opinion or a
disclaimer of opinion or was qualified
as to uncertainties, audit scope, or
accounting principles, and must
describe the nature of each such adverse
opinion, disclaimer of opinion, or
qualification. The broker or dealer must
also request the former independent
public accountant to furnish the broker
or dealer with a letter addressed to the
Commission stating whether the
independent public accountant agrees
with the statements contained in the
notice of the broker or dealer and, if not,
stating the respects in which
independent public accountant does not
agree. The broker or dealer must file
three copies of the notice and the
accountant’s letter, one copy of which
must be manually signed by the sole
proprietor, a general partner, or a duly
authorized corporate, limited liability
company, or limited liability
partnership officer or member, as
appropriate, and by the independent
public accountant, respectively.
(g) Engagement of independent public
accountant. The independent public
accountant engaged by the broker or
dealer to provide the reports required
under paragraph (d)(1)(i)(C) of this
section must, as part of the engagement,
undertake the following, as applicable:
(1) To prepare an independent public
accountant’s report based on an
examination of the financial report
required to be filed by the broker or
dealer under paragraph (d)(1)(i)(A) of
this section in accordance with
standards of the Public Company
Accounting Oversight Board; and
(2)(i) To prepare an independent
public accountant’s report based on an
examination of the statements required
under paragraphs (d)(3)(i)(A)(2) through
(5) of this section in the compliance
report required to be filed by the broker
or dealer under paragraph (d)(1)(i)(B)(1)
of this section in accordance with
standards of the Public Company
Accounting Oversight Board; or
(ii) To prepare an independent public
accountant’s report based on a review of
the statements required under
paragraphs (d)(4)(i) through (iii) of this
section in the exemption report required
to be filed by the broker or dealer under
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paragraph (d)(1)(i)(B)(2) of this section
in accordance with standards of the
Public Company Accounting Oversight
Board.
(h) Notification of non-compliance or
material weakness. If, during the course
of preparing the independent public
accountant’s reports required under
paragraph (d)(1)(i)(C) of this section, the
independent public accountant
determines that the broker or dealer is
not in compliance with § 240.15c3–1,
§ 240.15c3–3, or § 240.17a–13 or any
rule of the designated examining
authority of the broker or dealer that
requires account statements to be sent to
the customers of the broker or dealer, as
applicable, or the independent public
accountant determines that any material
weaknesses (as defined in paragraph
(d)(3)(iii) of this section) exist, the
independent public accountant must
immediately notify the chief financial
officer of the broker or dealer of the
nature of the non-compliance or
material weakness. If the notice from the
accountant concerns an instance of noncompliance that would require a broker
or dealer to provide a notification under
§ 240.15c3–1, § 240.15c3–3, or
§ 240.17a–11, or if the notice concerns
a material weakness, the broker or
dealer must provide a notification in
accordance with § 240.15c3–1,
§ 240.15c3–3, or § 240.17a–11, as
applicable, and provide a copy of the
notification to the independent public
accountant. If the independent public
accountant does not receive the
notification within one business day, or
if the independent public accountant
does not agree with the statements in
the notification, then the independent
public accountant must notify the
Commission and the designated
examining authority within one
business day. The report from the
accountant must, if the broker or dealer
failed to file a notification, describe any
instances of non-compliance that
required a notification under
§ 240.15c3–1, § 240.15c3–3, or
§ 240.17a–11, or any material
weaknesses. If the broker or dealer filed
a notification, the report from the
accountant must detail the aspects of
the notification of the broker or dealer
with which the accountant does not
agree.
Note to paragraph (h): The attention of
the broker or dealer and the
independent public accountant is called
to the fact that under § 240.17a–11(b)(1),
among other things, a broker or dealer
whose net capital declines below the
minimum required pursuant to
§ 240.15c3–1 shall give notice of such
deficiency that same day in accordance
with § 240.17a–11(g) and the notice
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shall specify the broker or dealer’s net
capital requirement and its current
amount of net capital. The attention of
the broker or dealer and accountant also
is called to the fact that under
§ 240.15c3–3(i), if a broker or dealer
shall fail to make a reserve bank account
or special account deposit, as required
by § 240.15c3–3, the broker or dealer
shall by telegram immediately notify the
Commission and the regulatory
authority for the broker or dealer, which
examines such broker or dealer as to
financial responsibility and shall
promptly thereafter confirm such
notification in writing.
(i) Reports of the independent public
accountant required under paragraph
(d)(1)(i)(C) of this section—(1) Technical
requirements. The independent public
accountant’s reports must:
(i) Be dated;
(ii) Be signed manually;
(iii) Indicate the city and state where
issued; and
(iv) Identify without detailed
enumeration the items covered by the
reports.
(2) Representations. The independent
public accountant’s reports must:
(i) State whether the examinations or
review, as applicable, were made in
accordance with standards of the Public
Company Accounting Oversight Board;
(ii) Identify any examination and, if
applicable, review procedures deemed
necessary by the independent public
accountant under the circumstances of
the particular case that have been
omitted and the reason for their
omission.
(iii) Nothing in this section may be
construed to imply authority for the
omission of any procedure that
independent public accountants would
ordinarily employ in the course of an
examination or review made for the
purpose of expressing the opinions or
conclusions required under this section.
(3) Opinion or conclusion to be
expressed. The independent public
accountant’s reports must state clearly:
(i) The opinion of the independent
public accountant with respect to the
financial report required under
paragraph (d)(1)(i)(A) of this section and
the accounting principles and practices
reflected in that report;
(ii) The opinion of the independent
public accountant with respect to the
financial report required under
paragraph (d)(1)(i)(A) of this section, as
to the consistency of the application of
the accounting principles, or as to any
changes in those principles, that have a
material effect on the financial
statements; and
(iii)(A) The opinion of the
independent public accountant with
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respect to the statements required under
paragraphs (d)(3)(i)(A)(2) through (5) of
this section in the compliance report
required under paragraph (d)(1)(i)(B)(1)
of this section; or
(B) The conclusion of the
independent public accountant with
respect to the statements required under
paragraphs (d)(4)(i) through (iii) of this
section in the exemption report required
under paragraph (d)(1)(i)(B)(2) of this
section.
(4) Exceptions. Any matters to which
the independent public accountant
takes exception must be clearly
identified, the exceptions must be
specifically and clearly stated, and, to
the extent practicable, the effect of each
such exception on any related items
contained in the annual reports required
under paragraph (d) of this section must
be given.
*
*
*
*
*
■ 3. Section 240.17a–11 is amended by:
■ a. Revising paragraph (e); and
■ b. In paragraph (h), removing the
citation ‘‘17a–5(h)(2)’’ and adding in its
place the citation ‘‘17a–5(h)’’ and
removing the citation ‘‘17a–12(f)(2)’’
and adding in its place the citation
‘‘17a–12(i)(2).’’
The revision reads as follows:
§ 240.17a–11 Notification provision for
brokers and dealers.
*
*
*
*
*
(e) Whenever any broker or dealer
discovers, or is notified by an
independent public accountant under
§ 240.17a–12(i)(2), of the existence of
any material inadequacy as defined in
§ 240.17a–12(h)(2), or whenever any
broker or dealer discovers, or is notified
by an independent public accountant
under § 240.17a–5(h), of the existence of
any material weakness as defined in
§ 240.17a–5(d)(3)(iii), the broker or
dealer must:
(1) Give notice, in accordance with
paragraph (g) of this section, of the
material inadequacy or material
weakness within 24 hours of the
discovery or notification of the material
inadequacy or the material weakness;
and
(2) Transmit a report, in accordance
with paragraph (g) of this section,
within 48 hours of the notice stating
what the broker or dealer has done or
is doing to correct the situation.
*
*
*
*
*
PART 249—FORMS, SECURITIES
EXCHANGE ACT OF 1934
4. The authority citation for part 249
continues to read, in part, as follows:
■
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
Authority: 15 U.S.C. 78a et seq. and 7201
et seq.; 12 U.S.C. 5461 et seq.; and 18 U.S.C.
1350, unless otherwise noted.
*
*
*
§ 249.639
5. Add Form Custody (referenced in
§ 249.639) to subpart G to read as
follows:
*
Subpart G—Forms for Reports To Be
Made by Certain Exchange Members,
Brokers, and Dealers
Note: The text of Form Custody will not
appear in the Code of Federal Regulations.
*
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Form custody.
This form shall be used for reports of
information required by § 240.17a–5 of
this chapter.
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
Dated: July 30, 2013.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013–18738 Filed 8–20–13; 8:45 am]
BILLING CODE 8011–01–C
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By the Commission.
52003
]]>Agencies
[Federal Register Volume 78, Number 162 (Wednesday, August 21, 2013)]
[Rules and Regulations]
[Pages 51909-52003]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-18738]
[[Page 51909]]
Vol. 78
Wednesday,
No. 162
August 21, 2013
Part III
Securities and Exchange Commission
-----------------------------------------------------------------------
17 CFR Parts 240 and 249
Broker-Dealer Reports; Final Rule
Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 /
Rules and Regulations
[[Page 51910]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 249
[Release No. 34-70073; File No. S7-23-11]
RIN 3235-AK56
Broker-Dealer Reports
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``Commission''), under
the Securities Exchange Act of 1934 (``Exchange Act''), is amending
certain broker-dealer annual reporting, audit, and notification
requirements. The amendments include a requirement that broker-dealer
audits be conducted in accordance with standards of the Public Company
Accounting Oversight Board (``PCAOB'') in light of explicit oversight
authority provided to the PCAOB by the Dodd-Frank Wall Street Reform
and Consumer Protection Act (``Dodd-Frank Act'') to oversee these
audits. The amendments further require a broker-dealer that clears
transactions or carries customer accounts to agree to allow
representatives of the Commission or the broker-dealer's designated
examining authority (``DEA'') to review the documentation associated
with certain reports of the broker-dealer's independent public
accountant and to allow the accountant to discuss the findings relating
to the reports of the accountant with those representatives when
requested in connection with a regulatory examination of the broker-
dealer. Finally, the amendments require a broker-dealer to file a new
form with its DEA that elicits information about the broker-dealer's
practices with respect to the custody of securities and funds of
customers and non-customers.
DATES: This rule is effective June 1, 2014, except the amendment to
Sec. 240.17a-5(e)(5), which is effective October 21, 2013 and the
amendments to Sec. 240.17a-5(a) and (d)(6) and Sec. 249.639, which
are effective December 31, 2013.
FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, at (202) 551-5525; Thomas K. McGowan, Deputy Associate
Director, at (202) 551-5521; Randall W. Roy, Assistant Director, at
(202) 551-5522; Mark M. Attar, Branch Chief, at (202) 551-5889; Rose
Russo Wells, Special Counsel, at (202) 551-5527; Sheila Dombal Swartz,
Special Counsel, at (202) 551-5545; or Kimberly N. Chehardy, Attorney,
at (202) 551-5791, Office of Financial Responsibility, Division of
Trading and Markets; or Kevin Stout, Senior Associate Chief Accountant,
at (202) 551-5930, Office of the Chief Accountant, Securities and
Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to
Rule 17a-5 (17 CFR 240.17a-5) and technical and conforming amendments
to Rule 17a-11 (17 CFR 240.17a-11) and is adopting Form Custody (17 CFR
249. 639) under the Exchange Act.
Contents
I. Background
A. Overview
B. Rules Governing Broker-Dealer Financial and Custodial
Responsibility
1. The Broker-Dealer Net Capital Rule
2. The Broker-Dealer Customer Protection Rule
3. The Broker-Dealer Quarterly Securities Count Rule
4. The Broker-Dealer Account Statement Rules
II. Final Amendments to Broker-Dealer Reporting, Audit,
Notification, and Other Requirements
A. Overview of New Requirements
B. Annual Reports To Be Filed--Paragraph (d) of Rule 17a-5
1. Requirement To File Reports--Paragraph (d)(1) of Rule 17a-5
i. Proposed Amendments
ii. Comments Received
iii. The Final Rule
2. The Financial Report--Paragraph (d)(2) of Rule 17a-5
3. The Compliance Report--Paragraph (d)(3) of Rule 17a-5
i. The Proposed Amendments
ii. Comments Received
iii. The Final Rule
4. The Exemption Report--Paragraph (d)(4) of Rule 17a-5
i. Proposed Amendments
ii. Comments Received
iii. The Final Rule
5. Time for Filing Annual Reports--Paragraph (d)(5) of Rule 17a-
5
6. Filing of Annual Reports with SIPC--Paragraph (d)(6) of Rule
17a-5
i. The Proposed Amendments
ii. Comments Received
iii. The Final Rule
C. The Nature and Form of the Annual Reports
1. Exemptions From Audit Requirement--Paragraph (e)(1) of Rule
17a-5
2. Affirmation--Paragraph (e)(2) of Rule 17a-5
3. Confidentiality of Annual Reports--Paragraph (e)(3) of Rule
17a-5
4. Supplemental Report on SIPC Membership--Paragraph (e)(4) of
Rule 17a-5
D. Engagement of the Accountant
1. Statutory Requirements and Commission Authority
2. Engagement of Accountant Requirements Prior to Today's
Amendments
3. Amended Engagement of Accountant Requirements
i. Proposed Amendments
ii. Comments
iii. The Final Rule
E. PCAOB Registration of Independent Public Accountant--
Paragraph (f)(1) of Rule 17a-5
F. Notification of Non-Compliance or Material Weakness
1. New Notification Requirements--Paragraph (h) of Rule 17a-5
i. The Proposed Amendments
ii. Comments Received
iii. The Final Rule
2. Conforming and Technical Amendments to Rule 17a-11
G. Other Amendments to Rule 17a-5
1. Information Provided to Customers--Paragraph (c) of Rule 17a-
5
i. Background
ii. Availability of Independent Public Accountant's Comments on
Material Inadequacies--Paragraph (c)(2) of Rule 17a-5
iii. Exemption From Mailing Financial Information to Customers--
Paragraph (c)(5) of Rule 17a-5
2. Technical Amendments
i. Deletion of Paragraph (b)(6) of Rule 17a-5
ii. Deletion of Provisions Relating to the Year 2000
iii. Deletion of Paragraph (i)(5) of Rule 17a-5
iv. Amendments to Paragraph (f)(2) of Rule 17a-5
v. Further Technical Amendments
H. Coordination With Investment Advisers Act Rule 206(4)-2
1. Background
2. Rule 206(4)-2
3. Broker-Dealers Acting as Qualified Custodians Under Rule
206(4)-2
4. Proposal To Allow Report Based on Examination of Compliance
Report to Satisfy Rule 206(4)-2
i. The Proposal
ii. Comments on the Proposal
5. Adoption of Proposal Relating to Rule 206(4)-2
III. Access to Accountant and Audit Documentation
IV. Form Custody
A. Background
B. Filing of Form Custody
1. Requirement to File Form Custody with FOCUS Reports
2. Requests for Exemption From Filing Form Custody
3. Attest Engagement Not Required for Form Custody
C. Form Custody
1. Item 1--Accounts Introduced on a Fully Disclosed Basis
2. Item 2--Accounts Introduced on an Omnibus Basis
3. Item 3--Carrying Broker-Dealers
i. Items 3.A and 3.B
ii. Item 3.C
a. Background
b. General Comments to Item 3.C
c. Item 3.C.i
d. Item 3.C.ii
e. Item 3.C.iii
iii. Items 3.D and 3.E
a. Items 3.D.i and 3.E.i
b. Items 3.D.ii and 3.E.ii
[[Page 51911]]
c. Items 3.D.iii and 3.E.iii
4. Item 4--Carrying for Other Broker-Dealers
5. Item 5--Trade Confirmations
6. Item 6--Account Statements
7. Item 7--Electronic Access to Account Information
8. Item 8--Broker-Dealers Registered as Investment Advisers
9. Item 9--Broker-Dealers Affiliated with Investment Advisers
V. Effective Dates
A. Amendments Effective 60 Days After Publication in the Federal
Register
B. Amendments Effective on December 31, 2013
C. Amendments Effective on June 1, 2014
VI. Paperwork Reduction Act
A. Summary of the Collection of Information Requirements
B. Use of Information
C. Respondents
D. Total Initial and Annual Burdens
1. Annual Reports To Be Filed
i. The Financial Report
ii. The Compliance Report
iii. The Exemption Report
iv. Additional Burden and Cost To File the Annual Reports
v. Supplemental Report on SIPC Membership
vi. Statement Regarding Independent Public Accountant
vii. External Costs of Engagement of Accountant
a. Financial Report (including Change from GAAS to PCAOB
Standards)
b. Compliance Report
c. Exemption Report
d. Access to Accountant and Audit Documentation
2. Conforming and Technical Amendments to Rule 17a-11
3. Form Custody
E. Collection of Information Is Mandatory
F. Confidentiality
VII. Economic Analysis
A. Motivation for the Amendments
B. Economic Baseline
1. Broker-Dealers
2. Independent Public Accountants That Audit Broker-Dealer
Reports
3. SIPC Lawsuits Against Accountants
4. Overview of Broker-Dealer Reporting, Auditing, and
Notification Requirements Before Today's Amendments
i. Broker-Dealer Reporting
ii. Engagement of the Accountant
iii. Filing of Annual Reports with SIPC
iv. Notification Requirements
v. Information Provided to Customers
vi. Access to Accountants and Audit Documentation
vii. Form Custody
C. Costs and Benefits of the Rule Amendments
1. Broker-Dealer Annual Reporting Amendments
i. Changing the Broker-Dealer Audit Standard Setter From the
AICPA to the PCAOB and the Standards From GAAS to PCAOB Standards
ii. Requirement To File New Reports
a. Compliance Report
b. Exemption Report
iii. Engagement of the Accountant
iv. Filing of Annual Reports With SIPC
v. Notification Requirements
a. Amendments to Rule 17a-5
b. Conforming and Technical Amendments to Rule 17a-11
vi. Information Provided to Customers
vii. Coordination With Investment Advisers Act Rule 206(4)-2
2. Access to Accountant and Audit Documentation
3. Form Custody
4. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
VIII. Final Regulatory Flexibility Analysis
A. Need for and Objectives of the Amendments and New Form
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Rules
D. Reporting, Recordkeeping, and Other Compliance Requirements
E. Agency Action To Minimize Effect on Small Entities
IX. Statutory Authority
I. Background
A. Overview
In 2009, the Commission began reviewing rules regarding the
safekeeping of investor assets in connection with several cases the
Commission brought alleging fraudulent conduct by investment advisers
and broker-dealers, including, among other things, misappropriation or
other misuse of customer securities and funds.\1\ As part of the rule
review effort, the Commission amended Rule 206(4)-2 under the
Investment Advisers Act of 1940 (``Rule 206(4)-2''), which governs the
custody of client securities and funds by investment advisers.\2\ When
adopting this amendment, the Commission stated that it represented ``a
first step in the effort to enhance custody protections, with
consideration of additional enhancements of the rules governing custody
of customer assets by broker-dealers to follow.'' \3\
---------------------------------------------------------------------------
\1\ See, e.g., SEC v. Bernard L. Madoff, et al., Litigation
Release No. 20889 (Feb. 9, 2009); SEC v. Stanford International
Bank, et al., Litigation Release No. 20901 (Feb. 17, 2009); SEC v.
Donald Anthony Walker Young, et al., Litigation Release No. 21006
(Apr. 20, 2009); SEC v. Isaac I. Ovid, et al., Litigation Release
No. 20998 (Apr. 14, 2009); SEC v. The Nutmeg Group, LLC, et al.,
Litigation Release No. 20972 (Mar. 25, 2009); SEC v. WG Trading
Investors, L.P., et al., Litigation Release No. 20912 (Feb. 25,
2009).
\2\ See Custody of Funds or Securities of Clients by Investment
Advisers, Investment Advisers Act of 1940 (``Advisers Act'') Release
No. 2968 (Dec. 30, 2009), 75 FR 1456 (Jan. 11, 2010). See also 17
CFR 275.206(4)-2.
\3\ See Custody of Funds or Securities of Clients by Investment
Advisers, 75 FR at 1456.
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In June 2011, the Commission proposed rule amendments and a new
form designed, among other things, to provide additional safeguards
with respect to broker-dealer custody of customer securities and
funds.\4\ The proposed amendments would have amended certain annual
reporting, audit, and notification requirements for broker-dealers.\5\
The proposed amendments also would have required a broker-dealer that
clears transactions or carries customer accounts (each, a ``clearing
broker-dealer'') to agree to allow representatives of the Commission or
the broker-dealer's DEA to review the documentation associated with
certain reports of the broker-dealer's independent public accountant
and to allow the accountant to discuss with representatives of the
Commission or DEA the accountant's findings associated with those
reports when requested in connection with an examination of the broker-
dealer.\6\ Further, the proposed amendments would have required a
broker-dealer to file with its DEA on a quarterly basis a new form--
Form Custody--that would have elicited information as to whether, and
if so how, a broker-dealer maintains custody of securities and funds of
customers and others.\7\ The Commission also proposed requiring that a
broker-dealer file its annual reports with the Securities Investor
Protection Corporation (``SIPC'').\8\
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\4\ See Broker-Dealer Reports, Exchange Act Release No. 64676
(June 15, 2011), 76 FR 37572 (June 27, 2011).
\5\ Id. at 37575-37583.
\6\ Id. at 37583-37584.
\7\ Id. at 37584-37592.
\8\ Id. at 37592-37594.
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The proposed amendments were designed to enhance the ability of the
Commission to oversee broker-dealer custody practices and, among other
things, to: (1) Increase the focus of broker-dealers that maintain
custody of customer funds and securities (``carrying broker-dealers'')
and their independent public accountants on compliance, and internal
control over compliance, with certain financial and custodial
requirements; (2) strengthen and clarify broker-dealer audit and
reporting requirements in order to facilitate consistent compliance
with these requirements; (3) facilitate the ability of the PCAOB to
implement the explicit oversight authority over broker-dealer audits
provided to the PCAOB by the Dodd-Frank Act; \9\ (4) ensure that SIPC
receives the necessary information to assess whether the liquidation
fund it maintains is appropriately sized to the risks of a large
broker-dealer failure; (5) enable Commission and DEA examiners to
conduct risk-based examinations of carrying and clearing broker-dealers
by
[[Page 51912]]
assisting the examiners in selecting areas of focus for their
examinations; and (6) provide the Commission and the DEAs with a
comprehensive overview of a broker-dealer's custody practices.\10\
---------------------------------------------------------------------------
\9\ Public Law 111-203, 124 Stat. 1376, H.R. 4173 (July 21,
2010).
\10\ The proposed amendments also were designed to avoid
duplicative requirements for broker-dealers that are dually-
registered as investment advisers in view of the internal control
report requirement that was added by the amendment to Rule 206(4)-2.
See discussion below in section VII.A. of this release identifying
further motivations for the amendments.
---------------------------------------------------------------------------
The Commission received 27 comment letters on the proposal.\11\ The
Commission has considered the comments and, as discussed in detail
below, is adopting the amendments and the new form with modifications,
in part in response to comments received. A number of commenters stated
that the Commission should coordinate with the Commodity Futures
Trading Commission (``CFTC'') to account for broker-dealers that also
are registered as futures commission merchants (``FCMs'') in order to
align the broker-dealer reporting and audit requirements with FCM
reporting and audit requirements.\12\ The Commission staff is in
discussions with the CFTC staff concerning ways to align the reporting
and audit requirements for dually-registered broker-dealer/FCMs with
the goal of coordinating these requirements, including the requirements
that the Commission is adopting today.
---------------------------------------------------------------------------
\11\ Comment letter of Naphtali M. Hamlet (June 22, 2011)
(``Hamlet Letter''); comment letter of Robert R. Kelley (June 27,
2011) (``Kelley Letter''); comment letter of Chris Barnard (July 20,
2011) (``Barnard Letter''); comment letter of Suzanne Shatto (July
25, 2011) (``Shatto Letter''); comment letter of Suzanne H. Shatto
(July 25, 2011) (``Shatto Letter II''); comment letter of Todd
Genger (Aug. 2, 2011) (``Genger Letter''); comment letter of Suzanne
Shatto (Aug. 14, 2011) (``Shatto Letter III''); comment letter of
Deloitte & Touche LLP (Aug. 25, 2011) (``Deloitte Letter''); comment
letter of the Securities Industry and Financial Markets Association
(Aug. 25, 2011) (``SIFMA Letter''); comment letter of the Center for
Audit Quality (Aug. 25, 2011) (``CAQ Letter''); comment letter of
KPMG LLP (Aug. 25, 2011) (``KPMG Letter''); comment letter of
PricewaterhouseCoopers, LLP (Aug. 25, 2011) (``PWC Letter'');
comment letter of Citrin Cooperman & Co., LLP (Aug. 25, 2011)
(``Citrin Letter''); comment letter of Grant Thornton LLP (Aug. 26,
2011) (``Grant Thornton Letter''); comment letter of James J. Angel
(Aug. 26, 2011) (``Angel Letter''); comment letter of James J. Angel
(Aug. 26, 2011) (``Angel Letter II''); comment letter of McGladrey &
Pullen, LLP (Aug. 26, 2011) (``McGladrey Letter''); comment letter
of the Certified Financial Planner Board of Standards, Inc. (Aug.
26, 2011) (``CFP Letter''); comment letter of Integrated Management
Solutions USA LLC (Aug. 26, 2011) (``IMS Letter''); comment letter
of the American Institute of Certified Public Accountants (Aug. 26,
2011) (``AICPA Letter''); comment letter of the Committee of Annuity
Insurers (Aug. 26, 2011) (``CAI Letter''); comment letter of Ernst &
Young LLP (Aug. 26, 2011) (``E&Y Letter''); comment letter of Van
Kampen Funds Inc. and Invesco Distributors, Inc. (Aug. 26, 2011)
(``Van Kampen/Invesco Letter''); comment letter of Suzanne H. Shatto
(Sept. 13, 2011) (``Shatto Letter IV); comment letter N.M. Hamlet
(Sept. 14, 2011) (``Hamlet Letter II''); comment letter of the
Federal Regulation of Securities Committee, Business Law Section,
American Bar Association (Sept. 15, 2011) (``ABA Letter''); and
comment letter of the Committee of Annuity Insurers (Apr. 17, 2012)
(``CAI II Letter''). The comment letters are available on the
Commission's Web site at https://www.sec.gov/comments/s7-23-11/s72311.shtml. Comments are also available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street
NE., Washington, DC (File No. S7-23-11).
\12\ See CAQ Letter; Deloitte Letter; E&Y Letter; Grant Thornton
Letter; KPMG Letter; PWC Letter.
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B. Rules Governing Broker-Dealer Financial and Custodial Responsibility
Rule 15c3-1,\13\ Rule 15c3-3,\14\ and Rule 17a-13,\15\ under the
Exchange Act and applicable DEA rules that require broker-dealers to
periodically send account statements to customers (``Account Statement
Rules'') \16\ (collectively for the purposes of this release, ``the
financial responsibility rules'') are central to today's amendments to
the broker-dealer reporting, audit, and notification requirements. In
light of the significance of the financial responsibility rules to
today's amendments, the following section briefly summarizes the
requirements of each rule in order to provide a foundation for the
later discussion of the amendments.
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\13\ 17 CFR 240.15c3-1 (a rule prescribing net capital
requirements for broker-dealers).
\14\ 17 CFR 240.15c3-3 (a rule prescribing requirements
regarding the holding of customer securities and funds by broker-
dealers).
\15\ 17 CFR 240.17a-13 (a rule requiring broker-dealers to
perform quarterly securities counts).
\16\ See, e.g., Rule 9.12 of the Chicago Board Options Exchange
(``CBOE''); NASD Rule 2340 of the Financial Industry Regulatory
Authoirty (``FINRA'').
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1. The Broker-Dealer Net Capital Rule
Rule 15c3-1 requires broker-dealers to maintain a minimum level of
net capital (consisting of highly liquid assets) at all times.\17\ In
computing net capital, a broker-dealer must, among other things,
calculate net worth in accordance with U.S. generally accepted
accounting principles (``GAAP'') and then make certain adjustments to
net worth, such as deducting illiquid assets and taking other capital
charges and adding qualifying subordinated loans.\18\ The amount
remaining after these deductions is defined as ``tentative net
capital.'' \19\ The final step in computing net capital is to deduct
certain percentages (``haircuts'') from the market value of the broker-
dealer's proprietary positions to account for the market risk inherent
in the positions \20\ and to create a buffer of liquidity to protect
against other risks associated with the broker-dealer's business.\21\
The broker-dealer must cease conducting a securities business if the
amount of net capital maintained by the firm falls below the minimum
required amount.\22\
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\17\ See 17 CFR 240.15c3-1. The rule requires that a broker-
dealer perform two calculations: (1) A computation of the minimum
amount of net capital the broker-dealer must maintain; and (2) a
computation of the amount of net capital the broker-dealer is
maintaining. See 17 CFR 240.15c3-1(a) and (c)(2). The computation of
net capital is based on the definition of the term ``net capital''
in paragraph (c)(2) of Rule 15c3-1. Id. Generally, a broker-dealer's
minimum net capital requirement is the greater of a fixed-dollar
amount specified in the rule and an amount determined by applying
one of two financial ratios. See 17 CFR 240.15c3-1(a).
\18\ See 17 CFR 240.15c3-1(c)(2)(i)-(xiii).
\19\ See 17 CFR 240.15c3-1(c)(15).
\20\ See 17 CFR 240.15c3-1(c)(2)(vi).
\21\ See, e.g., Uniform Net Capital Rule, Exchange Act Release
No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977).
\22\ See 15 U.S.C. 78o(c)(3)(A).
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2. The Broker-Dealer Customer Protection Rule
Rule 15c3-3 imposes two key requirements on a carrying broker-
dealer: first, the broker-dealer must maintain physical possession or
control over customers' fully paid and excess margin securities; \23\
and second, the firm must maintain a reserve of funds or qualified
securities \24\ in an account at one or more banks that is at least
equal in value to the amount of net funds owed to customers.\25\ These
requirements are designed to protect customers by requiring broker-
dealers to segregate customers' securities and
[[Page 51913]]
funds from the broker-dealer's proprietary business activities. If the
broker-dealer fails financially, customers' securities and funds should
be readily available to be returned to customers. In addition, if the
failed broker-dealer is liquidated in a proceeding under the Securities
Investor Protection Act of 1970 (``SIPA''), as amended, the customers'
securities and funds should be isolated and readily identifiable as
``customer property'' and, consequently, available to be distributed to
customers ahead of other creditors.\26\
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\23\ See 17 CFR 240.15c3-3(d). Control means the broker-dealer
must hold these securities free of lien in one of several locations
specified in the rule (e.g., at a bank or clearing agency). See 17
CFR 240.15c3-3(c). The broker-dealer must make a daily determination
from its books and records (as of the preceding day) of the quantity
of fully paid and excess margin securities not in its possession or
control. See 17 CFR 240.15c3-3(d). If the amount in the broker-
dealer's possession or control is less than the amount indicated as
being held for customers on the broker-dealer's books and records,
the broker-dealer generally must initiate steps to retrieve customer
securities from non-control locations or otherwise obtain possession
of them or place them in control locations. Id. The terms fully paid
securities, margin securities, and excess margin securities are
defined in Rule 15c3-3. See 17 CFR 240.15c3-3(a)(3), (a)(4), and
(a)(5), respectively.
\24\ The term qualified security is defined in Rule 15c3-3 to
mean a security issued by the U.S. or a security in respect of which
the principal and interest are guaranteed by the U.S. See 17 CFR
240.15c3-3(a)(6).
\25\ See 17 CFR 240.15c3-3(e). The amount of the net funds owed
to customers (``customer reserve requirement'') is computed by
adding customer credit items (e.g., cash in securities accounts) and
subtracting from that amount customer debit items (e.g., margin
loans) pursuant to a formula in Exhibit A to Rule 15c3-3. See 17 CFR
240.15c3-3a. Carrying broker-dealers are required to compute the
customer reserve requirement on a weekly basis, except where
customer credit balances do not exceed $1 million (in which case the
computation can be performed monthly, although the broker-dealer
must maintain 105% of the required deposit amount and may not exceed
a specified aggregate indebtedness limit). See 17 CFR 240.15c3-
3(e)(3).
\26\ See 15 U.S.C. 78aaa et seq.
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Provisions of Rule 15c3-3 exempt a broker-dealer from the
requirements of Rule 15c3-3 under certain circumstances.\27\ Generally,
a broker-dealer is exempt from Rule 15c3-3 if it does not hold customer
securities or funds, or, if it does receive customer securities or
funds, it promptly delivers the securities or promptly transmits the
funds to appropriate persons.\28\
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\27\ See 17 CFR 240.15c3-3(k).
\28\ Id.
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3. The Broker-Dealer Quarterly Securities Count Rule
Rule 17a-13 generally requires a broker-dealer that maintains
custody of securities (proprietary, customer, or both), on a quarterly
basis, to physically examine and count the securities it holds, account
for the securities that are subject to its control or direction but are
not in its physical possession (e.g., securities held at a control
location), verify the locations of securities under certain
circumstances, and compare the results of the count and verification
with its records.\29\ In accordance with a schedule, the broker-dealer
must take an operational capital charge under Rule 15c3-1 for short
securities differences (which include securities positions reflected on
the broker-dealer's securities record that are not susceptible to
either count or confirmation) that are unresolved after discovery.\30\
The differences also must be recorded in the broker-dealer's books and
records.\31\
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\29\ See 17 CFR 240.17a-13(b).
\30\ See 17 CFR 240.15c3-1(c)(2)(v).
\31\ See 17 CFR 240.17a-3(a)(4)(vi).
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4. The Broker-Dealer Account Statement Rules
The Account Statement Rules of DEAs require member broker-dealers
to send, at least once every calendar quarter, a statement of account
containing a description of any securities positions, money balances,
or account activity to each customer whose account had a security
position, money balance, or account activity during the period since
the last such statement was sent to the customer.\32\ The Account
Statement Rules provide a key safeguard for customers by requiring that
they receive information concerning securities positions and other
assets held in their accounts on a regular basis, which they can use to
identify discrepancies and monitor the performance of their accounts.
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\32\ See, e.g., CBOE Rule 9.12; NASD Rule 2340.
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II. Final Amendments to Broker-Dealer Reporting, Audit, Notification,
and Other Requirements
A. Overview of New Requirements
The Commission is adopting amendments to the reporting, audit, and
notification requirements in Rule 17a-5, and additional amendments to
other provisions of the rule, including technical changes. The
Commission also is adopting amendments to the notification requirements
in Rule 17a-11, and certain other technical amendments to that rule.
Under the amendments to the reporting and audit requirements,
broker-dealers must, among other things, file with the Commission
annual reports consisting of a financial report and either a compliance
report or an exemption report that are prepared by the broker-dealer,
as well as certain reports that are prepared by an independent public
accountant covering the financial report and the compliance report or
the exemption report.\33\ The filing of a compliance or exemption
report and the related report of the independent public accountant are
new requirements. The financial report must contain the same types of
financial statements that were required to be filed under Rule 17a-5
prior to these amendments (a statement of financial condition, a
statement of income, a statement of cash flows, and certain other
financial statements).\34\ In addition, the financial report must
contain, as applicable, the supporting schedules that were required to
be filed under Rule 17a-5 prior to these amendments (a computation of
net capital under Rule 15c3-1, a computation of the reserve
requirements under Rule 15c3-3, and information relating to the
possession or control requirements under Rule 15c3-3).\35\
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\33\ See paragraph (d) of Rule 17a-5.
\34\ See paragraph (d)(2)(i) of Rule 17a-5. The requirements for
the financial report are discussed below in more detail in section
II.B.2. of this release.
\35\ See paragraph (d)(2)(ii) of Rule 17a-5.
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A broker-dealer that did not claim that it was exempt from Rule
15c3-3 throughout the most recent fiscal year must file the compliance
report, and a broker-dealer that did claim it was exempt from Rule
15c3-3 throughout the most recent fiscal year (generally, a ``non-
carrying broker-dealer'') must file the exemption report.\36\ Broker-
dealers must make certain statements and provide certain information
relating to the financial responsibility rules in these reports.\37\
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\36\ See paragraphs (d)(1)(i)(B)(1) and (2) of Rule 17a-5.
\37\ See paragraphs (d)(3) and (4) of Rule 17a-5. The
requirements for the compliance report and the exemption report are
discussed below in more detail in section II.B.3. and section
II.B.4. of this release, respectively.
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In addition to preparing and filing the financial report and the
compliance report or exemption report, a broker-dealer must engage a
PCAOB-registered independent public accountant to prepare a report
based on an examination of the broker-dealer's financial report in
accordance with PCAOB standards.\38\ A carrying broker-dealer also must
engage the PCAOB-registered independent public accountant to prepare a
report based on an examination of certain statements in the broker-
dealer's compliance report.\39\ A non-carrying broker-dealer must
engage the PCAOB-registered independent public accountant to prepare a
report based on a review of certain statements in the broker-dealer's
exemption report.\40\ In each case, the examination or review must be
conducted in accordance with PCAOB standards. The broker-dealer must
file these reports with the Commission along with the financial report
and the compliance report or exemption report prepared by the broker-
dealer.\41\
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\38\ See paragraphs (f)(1) and (g)(1) of Rule 17a-5.
\39\ See paragraphs (f)(1) and (g)(2)(i) of Rule 17a-5.
\40\ See paragraphs (f)(1) and (g)(2)(ii) of Rule 17a-5.
\41\ See paragraph (d)(1)(i)(C) of Rule 17a-5. The requirements
for the engagement of the independent public accountant are
discussed below in more detail in section II.D.3. of this release.
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The annual reports also must be filed with SIPC if the broker-
dealer is a member of SIPC.\42\ In addition, broker-dealers must
generally file with SIPC a supplemental report on the status of the
membership of the broker-dealer in SIPC.\43\ The supplemental report
must include a report of the independent public accountant that covers
the SIPC annual general assessment reconciliation or exclusion from
membership forms based on certain
[[Page 51914]]
procedures specified in the rule. In the future, SIPC may determine the
format of this report by rule, subject to Commission approval.\44\
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\42\ See paragraph (d)(6) of Rule 17a-5. This requirement is
discussed below in more detail in section II.B.6. of this release.
\43\ See paragraph (e)(4) of Rule 17a-5. This requirement is
discussed below in more detail in section II.C.4. of this release.
\44\ Id. Currently, Rule 17a-5 prescribes the format of the
report. See 17 CFR 240.17a-5.
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Finally, the PCAOB-registered independent public accountant must
immediately notify the broker-dealer if the accountant determines
during the course of preparing the accountant's reports that the
broker-dealer is not in compliance with the financial responsibility
rules or if the accountant determines that any material weakness exists
in the broker-dealer's internal control over compliance with the
financial responsibility rules.\45\ The broker-dealer, in turn, must
file a notification with the Commission and its DEA under Rule 15c3-1,
Rule 15c3-3, or Rule 17a-11 if the independent public accountant's
notice concerns an instance of non-compliance that would trigger
notification under those rules.\46\ Under the amendments to Rule 17a-
11, a broker-dealer also must file a notification with the Commission
and its DEA if the broker-dealer discovers or is notified by the
independent public accountant of the existence of any material weakness
(as defined in the amendments) in the broker-dealer's internal control
over compliance with the financial responsibility rules.\47\
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\45\ See paragraph (h) of Rule 17a-5. As discussed below,
material weakness is defined for purposes of the compliance report
and, therefore, the notification of a material weakness only can
occur in the context of the audit of a broker-dealer that files a
compliance report.
\46\ Id. Notifications under Rule 17a-11 also must be filed with
the CFTC if the broker-dealer is registered as a FCM with the CFTC.
See 17 CFR 240.17a-11(g).
\47\ See paragraph (e) of Rule 17a-11. These notification
provisions are discussed below in more detail in section II.F. of
this release.
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Each of these amendments is discussed in more detail in the
following sections of this release.
B. Annual Reports To Be Filed--Paragraph (d) of Rule 17a-5
Prior to today's amendments, paragraph (d) of Rule 17a-5 generally
required a broker-dealer to annually file the financial statements and
supporting schedules discussed below in section II.B.2. of this release
and a report prepared by the broker-dealer's independent public
accountant covering the financial statements and supporting
schedules.\48\ The Commission proposed amendments that would, among
other things, restructure paragraph (d) and--as part of the proposed
revisions to the attestation engagement provisions--add the requirement
that a broker-dealer file either a compliance report or an exemption
report, as applicable, and a report prepared by the broker-dealer's
independent public accountant based on an examination of the compliance
report or a review of the exemption report.\49\ As discussed in
sections II.B.1. through II.B.6. of this release, the Commission is
adopting the proposed amendments to paragraph (d) with
modifications.\50\
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\48\ See 17 CFR 240.17a-5(d)(1)(i). Certain types of broker-
dealers were exempt from the requirement to file the reports or to
file reports that had been audited by an independent public
accountant. See 17 CFR 240.17a-5(d)(1)(ii)-(iii).
\49\ See Broker-Dealer Reports, 76 FR at 37575-37581.
\50\ Before today's amendments, paragraph (d) of Rule 17a-5 was
titled ``Annual filing of audited financial statements.'' In the
proposing release, the Commission proposed to change the title to
``Annual reports'' to reflect that, under the proposed amendments to
paragraph (d), broker-dealers would be required to prepare and file
two reports with the Commission--a financial report and a compliance
report or an exemption report. See Broker-Dealer Reports, 76 FR at
37575. The Commission received no comments on this proposal and is
adopting the new title as proposed. See paragraph (d) of Rule 17a-5.
In addition, the Commission is making a technical amendment to
paragraph (d) of Rule 17a-5 to replace the term ``fiscal or calendar
year'' with the term ``fiscal year.'' The Commission is adopting
this technical amendment because the term ``fiscal year'' includes
instances in which December 31st, i.e., the calendar year end, is
the broker-dealer's fiscal year end.
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1. Requirement To File Reports--Paragraph (d)(1) of Rule 17a-5
i. Proposed Amendments
The Commission proposed to amend paragraph (d)(1) of Rule 17a-5
\51\ to require that a broker-dealer file a financial report containing
financial statements and supporting schedules and either a compliance
report or an exemption report, as applicable.\52\ The proposal provided
that a broker-dealer must file a compliance report ``unless the
[broker-dealer] is exempt from the provisions of [Rule 15c3-3]'' in
which case the broker-dealer would be required to file an exemption
report.\53\ The proposed amendments also would have required a broker-
dealer generally to file reports prepared by an independent public
accountant covering the financial report and compliance report or
exemption report, as applicable, unless the broker-dealer was exempt
from the requirement to file the reports or from the requirement to
engage an independent public accountant with respect to the
reports.\54\ To accommodate these changes, the Commission also proposed
to reorganize the provisions of paragraph (d)(1) of Rule 17a-5, and to
make other technical amendments.\55\
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\51\ See 17 CFR 240.17a-5(d)(1).
\52\ See Broker-Dealer Reports, 76 FR at 37575.
\53\ Id.
\54\ Id.
\55\ Id. at 37575-37578, 37603-37604.
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The proposed amendments with respect to the compliance report and
exemption report set forth different requirements for carrying broker-
dealers as compared with broker-dealers that do not hold customer
securities and funds.\56\ In order to provide clarity with respect to
this distinction, the proposed amendments referenced Rule 15c3-3, which
applies to carrying broker-dealers and contains provisions under which
a broker-dealer is exempt from the requirements in the rule. The goal
was to establish a clear way of determining whether a broker-dealer
would need to file a compliance report or an exemption report. However,
not all broker-dealers that are subject to Rule 15c3-3 regularly hold
customer securities or funds. This prompted the Commission to inquire
in the proposing release as to whether there are broker-dealers that
would not qualify to file the proposed exemption report because they
are not exempt from Rule 15c3-3, but that should be allowed to file a
more limited report than the proposed compliance report based on the
limited scope of their business.\57\
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\56\ Id. at 37575-37578, 37580-37581 (discussing the compliance
report and exemption report, respectively).
\57\ Id. at 37581.
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ii. Comments Received
The Commission received several comments on its proposed amendments
to paragraph (d)(1) of Rule 17a-5.\58\ Some commenters asked whether
the provision that would require the broker-dealer to file an exemption
report instead of a compliance report related to a period end date or
to a period of time.\59\ Further, as discussed in more detail in
sections II.B.4. and II.D.3. of this release, commenters raised
questions and concerns about how instances of exceptions to meeting the
exemption provisions of paragraph (k) of Rule 15c3-3 would be treated
under the proposed reporting requirements.\60\ One commenter also
stated that ``limited purpose'' carrying broker-dealers should not be
required to file a compliance report, and broker-dealers with certain
business model characteristics should not be required to file the
compliance report.\61\ Similarly, another commenter stated that broker-
dealers engaging
[[Page 51915]]
exclusively in proprietary trading or investment banking may not
technically be exempt from Rule 15c3-3 but nonetheless should not have
to file the compliance report as they do not have ``customers.'' \62\
Finally, one commenter stated that the Commission should clarify who
must sign the compliance reports and exemption reports and the
liability that attaches in the event of a misstatement or omission in
the reports.\63\
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\58\ See, e.g., CAI Letter; CAI II Letter; CAQ Letter; Citrin
Letter; Deloitte Letter; Grant Thornton Letter; KPMG Letter;
McGladrey Letter.
\59\ See CAQ Letter; Deloitte Letter; Grant Thornton Letter;
KPMG Letter.
\60\ See CAI Letter; SIFMA Letter.
\61\ See CAI Letter; CAI II Letter.
\62\ See McGladrey Letter.
\63\ See CAI Letter.
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iii. The Final Rule
After considering these comments, the Commission is adopting the
proposed amendments with certain modifications.\64\ Under the final
rule, all broker-dealers generally must prepare and file a financial
report and either the compliance report or the exemption report.\65\ A
broker-dealer that did not claim an exemption from Rule 15c3-3 at any
time during the most recent fiscal year or claimed an exemption for
only part of the fiscal year must prepare and file the compliance
report.\66\ A broker-dealer must prepare and file the exemption report
if the firm did claim that it was exempt from Rule 15c3-3 throughout
the most recent fiscal year.\67\ Broker-dealers also must file reports
prepared by a PCAOB-registered independent public accountant covering
the financial report and the compliance report or exemption report, as
applicable.\68\
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\64\ See paragraph (d)(1) of Rule 17a-5. Paragraph (d)(1)(iii)
of Rule 17a-5 (now re-designated as paragraph (d)(1)(iv)) contains
an exemption from filing an annual report if the broker-dealer is a
member of a national securities exchange and has transacted business
in securities solely with or for other members of a national
securities exchange, and has not carried any margin account, credit
balance or security for any person who is defined as a ``customer''
in paragraph (c)(4) of Rule 17a-5. See paragraph (d)(1)(iv) of Rule
17a-5. The Commission also proposed to move the exemptions from
having to file financial statements under paragraph (d) of Rule 17a-
5 from paragraphs (d)(1)(ii) and (d)(1)(iii) of Rule 17a-5 to
paragraphs (d)(1)(iii) and (d)(1)(iv), respectively. The Commission
received no comments on these amendments and is adopting them as
proposed. See paragraphs (d)(1)(iii) and (d)(1)(iv) of Rule 17a-5.
For clarity, the amendments to paragraph (d)(1)(i) of Rule 17a-5
include a reference to the exemptions from the requirement for a
broker-dealer to file the annual reports so that the paragraph now
states ``[e]xcept as provided in paragraphs (d)(1)(iii) and
(d)(1)(iv) of this section, every broker or dealer registered under
section 15 of the Act must file annually . . . .'' See paragraph
(d)(1)(i) of Rule 17a-5. As proposed, the final rule provided that
the reports must be filed annually ``on a calendar or fiscal year
basis.'' The final rule deletes the phrase ``on a calendar or fiscal
year basis'' as the rule provides elsewhere that the annual reports
must be filed on a fiscal year basis. Id. In addition, the
Commission proposed to move the requirement that reports under
paragraph (d) of Rule 17a-5 be as of the same fixed or determinable
date each year, unless a change is approved in writing by the
broker-dealer's DEA, from paragraph (d)(1)(i) of Rule 17a-5 to
paragraph (d)(1)(ii). The Commission received no comments on this
proposed amendment and is adopting it substantially as proposed. See
paragraph (d)(1)(ii) of Rule 17a-5. The final rule also includes a
technical modification from the proposal to require that the reports
required to be filed under paragraph (d) must be as of the same
``fiscal year end each year,'' rather than as of the same ``fixed or
determinable date each year.'' See paragraph (d)(1)(ii) of Rule 17a-
5. This change, by having the rule refer to the broker-dealer's
``fiscal year,'' eliminates outdated language and conforms the
language in paragraph (d) of Rule 17a-5 to language in paragraph (n)
of Rule 17a-5. See 17 CFR 240.17a-5(n). The final rule also adds a
clarifying cross-reference to the provision in Rule 17a-5 pursuant
to which a broker-dealer requests a change of its fiscal year end.
See paragraph (d)(1)(i) of Rule 17a-5. Furthermore, the final rule
requires that a copy of the written approval by the broker-dealer's
DEA of a change in the broker-dealer's fiscal year be sent to the
Commission's principal office in Washington, DC, in addition to the
regional office of the Commission for the region in which the
broker-dealer has its principal place of business. Id. This change
is consistent with paragraph (n) of Rule 17a-5, which requires that
when a broker-dealer changes its fiscal year, it must file a notice
with the Commission's principal office in Washington, DC as well as
the regional office of the Commission for the region in which the
broker-dealer has its principal place of business. See 17 CFR
240.17a-5(n).
\65\ See paragraph (d)(1)(i) of Rule 17a-5. The financial
report, compliance report, and exemption report are discussed below
in more detail in sections II.B.2., II.B.3., and II.B.4.,
respectively, of this release.
\66\ See paragraph (d)(1)(i)(B)(1) of Rule 17a-5.
\67\ See paragraph (d)(1)(i)(B)(2) of Rule 17a-5.
\68\ See paragraph (d)(1)(i)(C) of Rule 17a-5. The proposed
requirements and final rule with respect to the attestation
engagement for the independent public accountant are discussed below
in section II.D. of this release.
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The final rule is modified from the proposal in three key ways.
First, the final rule provides that the broker-dealer must file the
exemption report if it did ``claim that it was exempt'' from Rule 15c3-
3 \69\ throughout the most recent fiscal year.\70\ This modification
from the proposal--which provided that a broker-dealer ``shall'' file
the exemption report if the broker-dealer ``is exempt from the
provisions of [Rule 15c3-3]''--is designed to provide greater clarity
as to whether a broker-dealer must file the exemption report (as
opposed to the compliance report), particularly when the broker-dealer
had exceptions to meeting the exemption provisions in paragraph (k) of
Rule 15c3-3 during the fiscal year.\71\ Specifically, if the broker-
dealer claimed an exemption from Rule 15c3-3 in its Financial and
Operational Combined Uniform Single Reports (``FOCUS Reports'')
throughout the fiscal year,\72\ it must file the exemption report even
it had exceptions to the exemption provisions.\73\ Consequently, the
applicability of the exemption report under the final rule is based on
an objective and easily ascertainable factor: whether the broker-dealer
claimed an exemption from Rule 15c3-3 throughout the most recent fiscal
year.\74\
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\69\ See paragraph (d)(1)(i)(B)(2) of Rule 17a-5. A broker-
dealer claiming an exemption from Rule 15c3-3 is required to
indicate the basis for the exemption on the periodic reports it
files with securities regulators. See, e.g., Item 24 of Part IIa of
the Financial and Operational Combined Uniform Single Report. See 17
CFR 249.617.
\70\ As discussed below in more detail in section II.B.4. of
this release, the provisions of paragraph (k) of Rule 15c3-3
prescribe ``exemptions'' from the requirements of Rule 15c3-3. See
17 CFR 240.15c3-3(k)(1), (k)(2)(i), (k)(2)(ii), and (k)(3).
\71\ See CAI Letter; SIFMA Letter.
\72\ The FOCUS Reports are: Form X-17A-5 Schedule I; Form X-17A-
5 Part II; Form X-17A-5 Part IIa; Form X-17A-5 Part IIb; and Form X-
17A-5 Part III.
\73\ As discussed in detail below in section II.B.4. of this
release, a broker-dealer that has exceptions to meeting the
exemption provisions in paragraph (k) of Rule 15c3-3 must identify
them in the exemption report.
\74\ See discussion in section II.B.4. of this release. There
may be circumstances in which a broker-dealer has not held customer
securities or funds during the fiscal year, but does not fit into
one of the exemptive provisions listed under Item 24 of Part IIa.
Even though there is not a box to check on the FOCUS Report, these
broker-dealers should file an exemption report and related
accountant's report.
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As noted above, several commenters argued that broker-dealers that
engage in limited custodial activities and, therefore, are not exempt
from Rule 15c3-3, should not be required to file a compliance
report.\75\ Specifically, one of these commenters suggested that a
``new'' category of ``limited purpose'' broker-dealer with certain
business model characteristics should be addressed in the rule and that
this ``new'' category of broker-dealer should not be required to file
the compliance report.\76\ The Commission has considered these comments
but has determined not to provide for a broader exception from the
requirement to file a compliance report for broker-dealers with limited
custodial activities. The objectives of the compliance report and
related examination of the compliance report are intended, among other
things, to ``increase the focus of independent public accountants on
the custody practices of broker-dealers'' and to ``help identify
broker-dealers that have weak controls for safeguarding investor
assets.'' \77\ Therefore, broker-dealers that hold customer assets--
even if their custodial activities are limited--generally should be
subject to the requirement to file the compliance report and related
accountant's report.\78\
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\75\ See, e.g., CAI Letter; CAI II Letter; McGladrey Letter.
\76\ See CAI II Letter.
\77\ See Broker-Dealer Reports, 76 FR at 37599.
\78\ Broker-dealers with extremely limited custodial activities
(e.g., holding customer checks made out to a third party for limited
periods of time) could seek exemptive relief under section 36 of the
Exchange Act (15 U.S.C. 77mm) from the requirement to file the
compliance report and report of the independent public accountant
covering the compliance report.
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[[Page 51916]]
The level of effort required by carrying broker-dealers to prepare
a compliance report will depend on the nature and extent of their
activities. For example, the controls of a carrying broker-dealer that
engages in limited custodial activities could be less complex than the
controls of a carrying broker-dealer that engages in more extensive
custodial activities.\79\ Therefore, this requirement is intended to be
scalable so that a carrying broker-dealer with limited custodial
activities generally should have to expend less effort to support its
statements in the compliance report, particularly with respect to the
statements relating to Rules 15c3-3 and 17a-13.
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\79\ As discussed below in section II.D. of this release, the
PCAOB has proposed attestation standards for an independent public
accountant's examination of the compliance report and the review of
the exemption report. The proposed examination standard provides
procedural requirements for independent public accountants that are
``designed to be scalable based on the broker's or dealer's size and
complexity.'' See Proposed Standards for Attestation Engagements
Related to Broker and Dealer Compliance or Exemption Reports
Required by the U.S. Securities and Exchange Commission and Related
Amendments to PCAOB Standards, PCAOB Release No. 2011-004, PCAOB
Rulemaking Docket Matter No. 035 (July 12, 2011) at 8 (``PCAOB
Proposing Release'').
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The second key modification is that the final rule provides that
the requirement to file the exemption report applies if the broker-
dealer did claim that it was exempt from Rule 15c3-3 ``throughout the
most recent fiscal year.'' \80\ Thus, a broker-dealer that did not
claim an exemption from Rule 15c3-3 at any time during the most recent
fiscal year or claimed an exemption for only part of the fiscal year
must file the compliance report.\81\
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\80\ See paragraphs (d)(1)(i)(B)(1)-(2) of Rule 17a-5.
\81\ There will be cases where a broker-dealer changes its
business model to convert from a carrying broker-dealer to a non-
carrying broker-dealer during the fiscal year. In this case, the
broker-dealer could seek exemptive relief under section 36 of the
Exchange Act (15 U.S.C. 78mm) from the requirement to file the
compliance report and to instead file the exemption report. In
analyzing such a request, the period of time the broker-dealer
operated as a carrying broker-dealer would be a relevant
consideration.
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The third key modification is that the final rule specifies the
individual who must execute the compliance reports and exemption
reports.\82\ As noted above, one commenter stated that the Commission
should make clear who should sign the compliance reports and exemption
reports and what liability attaches in the event of a misstatement or
omission.\83\ The commenter suggested a reasonableness standard, and
stated that the Commission should make clear that the reports do not
create a new private right of action.\84\ In response to this comment,
the final rule provides that the compliance report and the exemption
report must be executed by the person who makes the oath or affirmation
under paragraph (e)(2) of Rule 17a-5.\85\ As discussed below in more
detail in section II.C.2. of this release, paragraph (e)(2) of Rule
17a-5 requires an oath or affirmation to be attached to the financial
report and provides that the oath or affirmation must be made by
certain types of persons depending on the corporate form of the broker-
dealer (e.g., a duly authorized officer if the broker-dealer is a
corporation).\86\ The requirement to file these new reports with the
Commission is not intended to establish a new private cause of action.
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\82\ See paragraphs (d)(1)(i)(B)(1)-(2) of Rule 17a-5.
\83\ See CAI Letter. The filings discussed above constitute a
``report'' for purposes of 15 U.S.C. 78ff(a) and other applicable
provisions of the Exchange Act. As a consequence, it would be
unlawful for a broker-dealer to willfully make or cause to be made,
a false or misleading statement of a material fact or omit to state
a material fact in the filings.
\84\ Id.
\85\ See paragraphs (d)(1)(i)(B)(1)-(2) of Rule 17a-5.
\86\ See paragraph (e)(2) of Rule 17a-5.
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2. The Financial Report--Paragraph (d)(2) of Rule 17a-5
Before today's amendments, paragraph (d)(2) of Rule 17a-5 required
that the annual audited report of a broker-dealer contain certain
financial statements in a format consistent with Form X-17A-5 Part II
or Form X-17A-5 Part IIa, as applicable, including a statement of
financial condition, an income statement, a statement of cash flows, a
statement of changes in owners' equity, and a statement of changes in
liabilities subordinated to claims of general creditors.\87\ Paragraph
(d)(3) of Rule 17a-5 required that the annual audited report contain
supporting schedules, including a computation of net capital under Rule
15c3-1, a computation for determining reserve requirements under Rule
15c3-3, and information relating to the possession and control
requirements of Rule 15c3-3.\88\ Paragraph (d)(4) of Rule 17a-5
required a reconciliation between the net capital and reserve
computations in the audited report and those in the most recent Form X-
17A-5 Part II or Form X-17A-5 Part IIa, if there were material
differences between the annual audited report and the form.\89\
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\87\ See 17 CFR 240.17a-5(d)(2). As noted above, Form X-17A-5
Part II and Form X-17A-5 Part IIa are among the FOCUS Reports that
broker-dealers complete and file with the Commission or their DEA on
a periodic basis. See 17 CFR 240.17a-5(a) and 17 CFR 249.617. These
two forms require broker-dealers to file monthly or quarterly
financial information with the Commission or their DEA, including
information about the broker-dealer's: (1) Assets and liabilities;
ownership equity; net capital computation under Rule 15c3-1; minimum
net capital requirement under Rule 15c3-1; income (loss);
computation of the customer reserve requirement under Rule 15c3-3 in
the case of Form X-17A-5 Part II; the possession and control
requirements under Rule 15c3-3 in the case of Form X-17A-5 Part II;
and changes in ownership equity.
\88\ See 17 CFR 240.17a-5(d)(3).
\89\ See 17 CFR 240.17a-5(d)(4).
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The Commission proposed combining the provisions in paragraphs
(d)(2) through (d)(4) of Rule 17a-5 in revised paragraph (d)(2) without
substantive modification to those provisions.\90\ In addition, the
Commission proposed that revised paragraph (d)(2) be titled ``Financial
report'' to reflect that the information required in this report would
be financial in nature and to differentiate it from the proposed
compliance reports and exemption reports. The Commission did not
receive comments concerning the amendments to paragraph (d)(2) of Rule
17a-5 and is adopting them substantially as proposed.\91\
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\90\ See Broker-Dealer Reports, 76 FR at 37575.
\91\ See paragraph (d)(2) of Rule 17a-5. The Commission has made
plain English changes to the language of the paragraph (e.g.,
replacing the term ``shall'' with ``must''). The Commission also,
consistent with current practice, has clarified that the financial
statements must be prepared in accordance with U.S. GAAP to
distinguish from other accounting frameworks. See paragraph (d)(2)
of Rule 17a-5. In addition, the Commission has replaced the words
``notes to the consolidated statement of financial condition'' with
``notes to the financial statements.'' This change in terminology is
designed to conform the language in Rule 17a-5 to current accounting
practice. Under GAAP, notes to a complete set of financial
statements must cover all the financial statements, and not just one
of the statements, such as the consolidated statement of financial
condition.
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3. The Compliance Report--Paragraph (d)(3) of Rule 17a-5
i. The Proposed Amendments
As proposed, the requirements for the contents of the compliance
report were prescribed in paragraph (d)(3) of Rule 17a-5.\92\ Under the
proposal, a carrying broker-dealer would need to include in the
compliance report a specific statement, certain assertions, and
descriptions.\93\ The independent public accountant would examine the
assertions in the compliance report in preparing the report of the
accountant.\94\
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\92\ See Broker-Dealer Reports, 76 FR at 37575-37578.
\93\ Id.
\94\ Id. The independent public accountant would not have been
required to examine the proposed ``statement'' and descriptions in
the compliance report.
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[[Page 51917]]
Specifically, as proposed, the carrying broker-dealer would be
required to include in the compliance report a statement as to whether
the firm has established and maintained a system of internal control to
provide the broker-dealer with reasonable assurance that any instances
of material non-compliance with the financial responsibility rules will
be prevented or detected on a timely basis.\95\ In addition, the
compliance report would need to include the following three assertions:
(1) Whether the broker-dealer was in compliance in all material
respects with the financial responsibility rules as of its fiscal year
end; (2) whether the information used to assert compliance with the
financial responsibility rules was derived from the books and records
of the broker-dealer; and (3) whether internal control over compliance
with the financial responsibility rules was effective during the most
recent fiscal year such that there were no instances of material
weakness.\96\ Finally, the carrying broker-dealer would need to include
in the compliance report a description of each identified instance of
material non-compliance and each identified material weakness in
internal control over compliance with the financial responsibility
rules.\97\ The independent public accountant would examine the
assertions in preparing the report of the accountant.\98\ The
independent public accountant would not examine the statement regarding
the establishment of the system of internal control.
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\95\ See Broker-Dealer Reports, 76 FR at 37575-37576.
\96\ Id.
\97\ Id.
\98\ Id. GAAS and PCAOB standards for attestation engagements
provide that accountants ordinarily should obtain written assertions
in an examination or review engagement. See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ] .09. Accordingly, the
Commission proposed that the independent public accountant's report
cover only the three assertions in the compliance report.
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Under the proposal, the broker-dealer would not be able to assert
compliance with the financial responsibility rules as of its most
recent fiscal year end if it identified one or more instances of
material non-compliance.\99\ Similarly, the broker-dealer would not be
able to assert that its internal control over compliance with the
financial responsibility rules during the fiscal year was effective if
one or more material weaknesses existed with respect to internal
control over compliance.\100\
---------------------------------------------------------------------------
\99\ See Broker-Dealer Reports, 76 FR at 37576-37577.
\100\ Id. at 37577.
---------------------------------------------------------------------------
An instance of material non-compliance was proposed to be defined
as a failure by the broker-dealer to comply with any of the
requirements of the financial responsibility rules in all material
respects.\101\ When determining whether an instance of non-compliance
is material, the Commission stated that the broker-dealer should
consider all relevant factors including but not limited to: (1) The
nature of the compliance requirements, which may or may not be
quantifiable in monetary terms; (2) the nature and frequency of non-
compliance identified; and (3) qualitative considerations.\102\ The
Commission also stated that some deficiencies would necessarily be
instances of material non-compliance, including failing to maintain the
required minimum amount of net capital under Rule 15c3-1 or failing to
maintain the minimum deposit requirement in a special reserve bank
account for the exclusive benefit of customers under Rule 15c3-3.\103\
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\101\ Id.
\102\ Id.
\103\ Id.
---------------------------------------------------------------------------
The term material weakness was proposed to be defined as a
deficiency, or a combination of deficiencies, in internal control over
compliance with the financial responsibility rules, such that there is
a reasonable possibility that material non-compliance with the
financial responsibility rules will not be prevented or detected on a
timely basis.\104\ The proposed definition of material weakness was
modeled on the definition of material weakness in a Commission rule--
Rule 1-02(a)(4) of Regulation S-X \105\--and in auditing literature
governing financial reporting.\106\ In the proposing release, the
Commission stated that a deficiency in internal control over compliance
would exist when the design or operation of a control does not allow
the broker-dealer, in the normal course of performing its assigned
functions, to prevent or detect non-compliance with the financial
responsibility rules on a timely basis.\107\ The Commission also stated
that, for purposes of the proposed definition of the term material
weakness, there is a reasonable possibility of an event occurring if it
is probable or reasonably possible.\108\ The Commission further stated
that an event is probable if the future event or events are likely to
occur and that an event is reasonably possible if the chance of the
future event or events occurring is more than remote, but less than
likely.\109\
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\104\ Id.
\105\ See 17 CFR 210.1-02(a)(4); 17 CFR 240.12b-2.
\106\ See PCAOB Auditing Standard, AS No. 5 app. A at ] A7;
American Institute of Certified Public Accountants (``AICPA''), AU
Section 325 at ] .06.
\107\ See Broker-Dealer Reports, 76 FR at 37577.
\108\ Id. See also Commission Guidance Regarding Management's
Report on Internal Control Over Financial Reporting Under Section
13(a) or 15(d) of the Securities Exchange Act of 1934, Securities
Act of 1933 Release No. 8810 (June 20, 2007), 72 FR 35324, 35332
n.47 and corresponding text (June 27, 2007).
\109\ Broker-Dealer Reports, 76 FR at 37577. The Commission has
stated in other contexts that there is a reasonable possibility of
an event occurring if it is ``probable'' or ``reasonably possible.''
See Amendments to Rules Regarding Management's Report on Internal
Control Over Financial Reporting, Exchange Act Release No. 55928
(June 20, 2007), 72 FR 35310 (June 27, 2007). See also 17 CFR
240.12b-2; 17 CFR 210.1-02. Commission guidance provides that an
event is ``probable'' if the future event or events are likely to
occur, and that an event is ``reasonably possible'' if the chance of
the future event or events occurring is more than remote, but less
than likely. See Commission Guidance Regarding Management's Report
on Internal Control Over Financial Reporting Under Section 13(a) or
15(d) of the Securities Exchange Act of 1934, 72 FR at 35332 n.47
and corresponding text.
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ii. Comments Received
The Commission received a number of comments on the proposed
compliance report. Generally, the comments focused on the intended
scope of the compliance report and the assertions to be included.
Specifically, many commenters raised concerns about what would
constitute ``material non-compliance.'' \110\ Several of these
commenters urged the Commission to provide guidance with additional
specific examples or quantitative and qualitative factors to be
considered when determining whether non-compliance was material.\111\
One commenter proposed alternate definitions for material non-
compliance and material weakness and provided examples of non-
compliance that should not be regarded as material.\112\
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\110\ See ABA Letter; CAI Letter; CAQ Letter; Deloitte Letter;
E&Y Letter; Grant Thornton Letter; KPMG Letter; McGladrey Letter;
PWC Letter; SIFMA Letter; Van Kampen/Invesco Letter.
\111\ See ABA Letter; CAQ Letter; E&Y Letter; KPMG Letter;
McGladrey Letter; PWC Letter.
\112\ See SIFMA Letter.
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Commenters also addressed the time period covered by the assertion
relating to effectiveness of internal control. In particular, some
commenters stated that the proposed assertion that internal control was
effective should be as of a point in time, as opposed to ``during the
fiscal year.'' \113\ One commenter stated that broker-dealers that must
file the internal control report required under
[[Page 51918]]
Rule 206(4)-2 should be able to elect to make the assertion pertain to
the entire fiscal year in order to satisfy reporting requirements under
the IA Custody Rule.\114\ Others stated that broker-dealers should have
the opportunity to remediate any material weaknesses in internal
control that were identified during the period and, if corrective
action was taken, not be required to include them in the compliance
report.\115\
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\113\ See Deloitte Letter; E&Y Letter; Grant Thornton Letter;
KPMG Letter.
\114\ See E&Y Letter. This commenter also stated that a point-
in-time assessment would be consistent with the requirement for
issuers subject to internal control reporting under section 404 of
the Sarbanes-Oxley Act. Further, for carrying broker-dealers that
are not subject to Rule 206(4)-2, this commenter stated that the
incremental benefits of having the assertion pertain to the entire
year rather than the year end assessment does not justify the cost.
Id.
\115\ See CAQ Letter; Deloitte Letter; McGladrey Letter.
---------------------------------------------------------------------------
Regarding the proposed assertion that the broker-dealer was in
compliance with the financial responsibility rules, one commenter
stated that broker-dealers may need to interpret certain requirements
and in other cases broker-dealers may be relying on informal
interpretations obtained through dialogue with the Commission or its
DEA.\116\ This commenter recommended that in those circumstances the
Commission require broker-dealers to formally document such
interpretations and obtain evidence of agreements reached with the
Commission or the DEA.
Some commenters stated that the Commission should provide
additional guidance about the control objectives that would need to be
met to achieve effective internal control over compliance with the
financial responsibility rules.\117\ Several commenters urged the
Commission to clarify the interaction between material weaknesses in
internal control over financial reporting and material weaknesses in
internal control over compliance with the financial responsibility
rules.\118\ One commenter stated that the compliance report was over-
inclusive and burdensome, and suggested that the final rule focus
instead on ``issues most vital to the financial condition of the
broker-dealer and its compliance and internal control over
compliance.'' \119\
---------------------------------------------------------------------------
\116\ See E&Y Letter.
\117\ See Angel Letter; Deloitte Letter.
\118\ See Deloitte Letter; KPMG Letter; PWC Letter.
\119\ See CAI Letter.
---------------------------------------------------------------------------
Some commenters had questions and comments about the proposed
assertion that information used to assert compliance with the financial
responsibility rules was derived from the books and records of the
broker-dealer. Three commenters asked whether ``books and records''
means records maintained under Rule 17a-3.\120\
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\120\ See CAQ Letter; Deloitte Letter; E&Y Letter.
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iii. The Final Rule
The Commission is adopting the proposed amendments to Rule 17a-5
requiring a carrying broker-dealer to prepare and file a compliance
report, with modifications, some of which are in response to
comments.\121\ Generally, as adopted, the broker-dealer's compliance
report will include five specific statements, and two descriptions, if
applicable.
---------------------------------------------------------------------------
\121\ See paragraph (d)(3) of Rule 17a-5.
---------------------------------------------------------------------------
Specifically, paragraph (d)(3) of Rule 17a-5 requires that the
compliance report contain statements as to whether: (1) The broker-
dealer has established and maintained Internal Control Over Compliance
(which, as discussed below, is a defined term in the final rule); (2)
the Internal Control Over Compliance of the broker-dealer was effective
during the most recent fiscal year; (3) the Internal Control Over
Compliance of the broker-dealer was effective as of the end of the most
recent fiscal year; (4) the broker-dealer was in compliance with Rule
15c3-1 and paragraph (e) of Rule 15c3-3 as of the end of the most
recent fiscal year; and (5) the information the broker-dealer used to
state whether it was in compliance with Rule 15c3-1 and paragraph (e)
of Rule 15c3-3 was derived from the books and records of the broker-
dealer. Further, if applicable, the compliance report must contain a
description of: (1) Each identified material weakness in the Internal
Control Over Compliance during the most recent fiscal year, including
those that were identified as of the end of the fiscal year; and (2)
any instance of non-compliance with Rule 15c3-1 or paragraph (e) of
Rule 15c3-3 as of the end of the most recent fiscal year.
The final rule does not use the term assertion--the assertions
contained in the proposal are now referred to as statements.\122\ The
consistent use of the term statements is designed to simplify the
structure of the rule rather than to substantively change the nature of
the matters stated in the compliance report or which of the statements
are to be examined by the independent public accountant.
---------------------------------------------------------------------------
\122\ See paragraphs (d)(3)(i)(A)(1)-(5) of Rule 17a-5.
---------------------------------------------------------------------------
In the final rule, the first statement in the compliance report is
whether the broker-dealer has established and maintained Internal
Control Over Compliance.\123\ The rule defines Internal Control Over
Compliance to mean internal controls that have the objective of
providing the broker-dealer with reasonable assurance that non-
compliance with the financial responsibility rules will be prevented or
detected on a timely basis.\124\ In order to clarify the application of
the rule, the proposal has been modified so that part of the statement
contained in the proposed compliance report, as to the broker-dealer's
system of internal control, has been incorporated in the definition of
Internal Control Over Compliance in the final rule.\125\ Under the
final rule, a broker-dealer cannot state that it has established and
maintained Internal Control Over Compliance if the internal controls do
not provide the broker-dealer with reasonable assurance that non-
compliance with the financial responsibility rules will be prevented or
detected on a timely basis.
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\123\ See paragraph (d)(3)(i)(A)(1) of Rule 17a-5.
\124\ See paragraph (d)(3)(ii) of Rule 17a-5.
\125\ Id.
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The final rule also provides that a broker-dealer is not permitted
to conclude that its Internal Control Over Compliance was effective if
there were one or more material weaknesses in its Internal Control Over
Compliance.\126\ A material weakness is defined as a deficiency, or a
combination of deficiencies, in the broker-dealer's Internal Control
Over Compliance such that there is a reasonable possibility \127\ that
non-compliance with Rule 15c3-1 or paragraph (e) of Rule 15c3-3 will
not be prevented or detected on a timely basis, or that non-compliance
to a material extent with Rule 15c3-3, except for paragraph (e), Rule
17a-13 or any Account Statement Rule will not be prevented or detected
on a timely
[[Page 51919]]
basis.\128\ A deficiency in Internal Control Over Compliance exists
when the design or operation of a control does not allow the management
or employees of the broker-dealer to prevent or detect on a timely
basis non-compliance with the financial responsibility rules in the
normal course of performing their assigned functions.
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\126\ See paragraph (d)(3)(iii) of Rule 17a-5. See also 17 CFR
229.308(a)(3) (providing that ``[m]anagement is not permitted to
conclude that the registrant's internal control over financial
reporting is effective if there are one or more material weaknesses
in the registrant's internal control over financial reporting.'').
\127\ As noted above, the Commission has stated in other
contexts that there is a reasonable possibility of an event
occurring if it is ``probable'' or ``reasonably possible.'' See
Amendments to Rules Regarding Management's Report on Internal
Control Over Financial Reporting, 72 FR 35310. See also 17 CFR
240.12b-2; 17 CFR 210.1-02. Commission guidance provides that an
event is ``probable'' if the future event or events are likely to
occur, and that an event is ``reasonably possible'' if the chance of
the future event or events occurring is more than remote, but less
than likely. See Commission Guidance Regarding Management's Report
on Internal Control Over Financial Reporting Under Section 13(a) or
15(d) of the Securities Exchange Act of 1934, 72 FR at 35332 n.47
and corresponding text.
\128\ See paragraph (d)(3)(iii) of Rule 17a-5. See also 17 CFR
240.12b-2; 17 CFR 210.1-02(a)(4) (providing that a ``[m]aterial
weakness means a deficiency, or a combination of deficiencies, in
internal controls over financial reporting . . . such that there is
a reasonable possibility that a material misstatement of the
registrant's annual or interim financial statements will not be
prevented or detected on a timely basis.'').
---------------------------------------------------------------------------
The final amendments reflect several other key changes from the
proposal. For example, one commenter stated that the compliance report
was overinclusive and burdensome, and therefore suggested that the
final rule focus on ``issues most vital to the financial condition of
the broker-dealer and its compliance and internal control over
compliance.'' \129\ The final rule requires a statement as to whether
the broker-dealer was in compliance with Rule 15c3-1 and paragraph (e)
of Rule 15c3-3 as of the end of the most recent fiscal year and, if
applicable, a description of any instances of non-compliance with these
rules as of the fiscal year end. This is a modification from the
proposed assertion that the broker-dealer is in compliance with the
financial responsibility rules in all material respects and proposed
description of any material non-compliance with the financial
responsibility rules. Thus, the final rule reflects two changes from
the proposal: (1) Elimination of the concepts of ``material non-
compliance'' and ``compliance in all material respects'' for the
purposes of reporting in the compliance report; and (2) a narrowing of
these statements and requirements from compliance with all of the
financial responsibility rules to compliance with Rule 15c3-1 and
paragraph (e) of Rule 15c3-3. In this way, the final rule more narrowly
focuses on the core requirements of the financial responsibility rules,
as suggested by the commenter.
---------------------------------------------------------------------------
\129\ See CAI Letter.
---------------------------------------------------------------------------
The ``material non-compliance'' and ``compliance in all material
respects'' concepts were designed to limit the types of instances of
non-compliance that would prevent a carrying broker-dealer from stating
that it was in compliance with the financial responsibility rules. In
order to retain a limiting principle, the final rule focuses on
provisions that trigger notification requirements when they are not
complied with, namely, Rule 15c3-1 and the customer reserve requirement
in paragraph (e) of Rule 15c3-3.\130\ Any instance of non-compliance
with these requirements as of the fiscal year end must be addressed in
the compliance report. As stated in the proposing release, failing to
maintain the required minimum amount of net capital under Rule 15c3-1
or failing to maintain the minimum deposit requirement in a special
reserve bank account under paragraph (e) of Rule 15c3-3 would have been
instances of material non-compliance under the proposed rule.\131\
Accordingly, under the proposal, a broker-dealer would have been
required to describe all instances of non-compliance with Rule 15c3-1
and paragraph (e) of Rule 15c3-3. Under the proposal, a broker-dealer
also would have been required to describe instances of material non-
compliance with Rule 17a-13 and the Account Statement Rules. The final
rule is narrower in that a broker-dealer is only required to describe
instances of non-compliance with Rule 15c3-1 and paragraph (e) of Rule
15c3-3.
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\130\ See 17 CFR 240.15c3-1(a)(6)(iv)(B), (a)(6)(v), (a)(7)(ii),
(a)(7)(iii), (c)(2)(x)(B)(1), (c)(2)(x)(F)(3) (notification
requirements with respect to Rule 15c3-1); 17 CFR 240.17a-11(b)-(c)
(notification requirements with respect to Rule 15c3-1); 17 CFR
240.15c3-3(i) (notification requirement in the event of a failure to
make a required deposit to the reserve account).
\131\ See Broker-Dealer Reports, 76 FR at 37577.
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Consistent with these changes, the final rule requires a statement
as to whether the carrying broker-dealer has established and maintained
Internal Control Over Compliance, which is defined as internal controls
that have the objective of providing the broker-dealer with reasonable
assurance that non-compliance with the financial responsibility rules
will be prevented or detected on a timely basis.\132\ The definition of
Internal Control Over Compliance modifies the proposed statement that
the carrying broker-dealer has established and maintained a system of
internal control to provide the firm with reasonable assurance that any
instances of material non-compliance with the financial responsibility
rules will be prevented or detected on a timely basis.\133\ Thus, the
definition eliminates the concept of material non-compliance.
Similarly, the proposed assertion as to whether the information used to
assert compliance with the financial responsibility rules was derived
from the books and records of the carrying broker-dealer has been
modified to a statement as to whether the information used to state
whether the carrying broker-dealer was in compliance with Rule 15c3-1
and paragraph (e) of Rule 15c3-3 was derived from the broker-dealer's
books and records.\134\
---------------------------------------------------------------------------
\132\ See paragraphs (d)(3)(i)(A)(1) and (d)(3)(ii) of Rule 17a-
5. As indicated above, the independent public accountant is not
required to examine this statement. See paragraph (g)(2)(i) of Rule
17a-5.
\133\ See paragraphs (d)(3)(i)(A)(1) and (d)(3)(ii) of Rule 17a-
5.
\134\ See paragraph (d)(3)(i)(A)(5) of Rule 17a-5.
---------------------------------------------------------------------------
The definition of material weakness similarly has been modified
from the proposal. Under the final rule, a material weakness would
include deficiencies in internal control relating to ``non-compliance''
with Rule 15c3-1 or paragraph (e) of Rule 15c3-3, and ``non-compliance
to a material extent'' with Rule 15c3-3, except for paragraph (e), Rule
17a-13, and the Account Statement Rules.\135\ This modification of the
definition of material weakness is based on the practical difficulties
in creating a system of control that will eliminate a reasonable
possibility of the occurrence of any instances of non-compliance with
certain requirements of the financial responsibility rules. For
example, the inadvertent failure to send one account statement out of
thousands of such statements would not constitute non-compliance to a
material extent with the Account Statement Rules though it would be an
instance of non-compliance.
---------------------------------------------------------------------------
\135\ See paragraph (d)(3)(iii) of Rule 17a-5.
---------------------------------------------------------------------------
Further, and consistent with current auditing standards, the
definition of ``deficiency in internal control'' in the final rule has
been modified to include the phrase ``the management or employees of
the broker or dealer'' in place of the phrase ``the broker or dealer.''
\136\
---------------------------------------------------------------------------
\136\ Id. See also PCAOB Auditing Standard, AS No. 5 app. A, at
] A3 (providing that ``[a] deficiency in internal control over
financial reporting exists when the design or operation of a control
does not allow management or employees, in the normal course of
performing their assigned functions, to prevent or detect
misstatements on a timely basis.'').
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The final rule--substantially as proposed--requires the carrying
broker-dealer to state whether its Internal Control Over Compliance was
effective during the most recent fiscal year.\137\ Some commenters
suggested that a broker-dealer that has remediated a material weakness
be permitted to provide an assertion about whether a material weakness
still exists at the end of the year, instead of having to state whether
internal control was effective during the most recent fiscal year.\138\
In light of the importance of a broker-dealer being in continual
compliance
[[Page 51920]]
with the financial responsibility rules, the Commission believes it is
appropriate for the broker-dealer's statement to address effectiveness
of its Internal Control Over Compliance throughout the fiscal year.
Consequently, the final rule requires the statement to cover the entire
fiscal year as opposed to the date that is the end of the fiscal year
as suggested by commenters.
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\137\ See paragraph (d)(3)(i)(A)(2) of Rule 17a-5.
\138\ See CAQ Letter; E&Y Letter; KPMG Letter; PWC Letter.
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However, in response to comments suggesting that the broker-dealer
be permitted to report the remediation or whether a material weakness
still exists at the end of the year,\139\ the final rule also requires
the carrying broker-dealer to state whether its Internal Control Over
Compliance was effective as of the end of the most recent fiscal
year.\140\ Thus, if there was a material weakness in the Internal
Control Over Compliance of the broker-dealer during the year that has
been addressed such that the broker-dealer no longer considers there to
be a material weakness at fiscal year end, the compliance report would
reflect both the identification of the material weakness and that its
Internal Control Over Compliance was effective as of the end of the
most recent fiscal year, thereby indicating that the material weakness
had been addressed as of the fiscal year end.
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\139\ See CAQ Letter; Deloitte Letter; E&Y Letter; McGladrey
Letter.
\140\ See paragraph (d)(3)(i)(A)(3) of Rule 17a-5.
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Consistent with these changes, the final rule provides that the
carrying broker-dealer cannot conclude that its Internal Control Over
Compliance was effective during the most recent fiscal year if there
were one or more material weaknesses in Internal Control Over
Compliance of the broker-dealer during the fiscal year.\141\ The final
rule adds a similar provision relating to the effectiveness of a
broker-dealer's Internal Control Over Compliance at the end of the most
recent fiscal year \142\ to respond to comments \143\ and to align with
the additional statement discussed above as to whether the broker-
dealer's Internal Control Over Compliance was effective as of the end
of the fiscal year.\144\
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\141\ See paragraph (d)(3)(iii) of Rule 17a-5. See also 17 CFR
229.308(a)(3) (providing that ``[m]anagement is not permitted to
conclude that the registrant's internal control over financial
reporting is effective if there are one or more material weaknesses
in the registrant's internal control over financial reporting.'').
\142\ See paragraph (d)(3)(iii) of Rule 17a-5.
\143\ See CAQ Letter; Deloitte Letter; E&Y Letter; McGladrey
Letter.
\144\ See paragraph (d)(3)(i)(A)(3) of Rule 17a-5.
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The final rule also retains the proposed requirement that the
carrying broker-dealer provide a description of each identified
material weakness in the broker-dealer's Internal Control Over
Compliance, but, in conformity with other modifications to the
proposal, the final rule requires that the material weaknesses include
those identified during the most recent fiscal year as well as those
that were identified as of the end of the fiscal year.\145\ This change
should not add a significant burden because broker-dealers should know
whether any material weaknesses identified before year end have been
remediated.
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\145\ See paragraph (d)(3)(i)(B) of Rule 17a-5.
---------------------------------------------------------------------------
As noted above, one commenter recommended that the Commission
require broker-dealers to document oral guidance obtained through
dialogue with Commission or DEA staff.\146\ While such a requirement
was not proposed and is not being adopted in the final rule, it may be
appropriate and prudent for a broker-dealer to maintain documentation
in its books and records of the matters discussed with the Commission
or DEA staff, the broker-dealer's own views and conclusion on those
matters, and any guidance received by the broker-dealer.
---------------------------------------------------------------------------
\146\ See E&Y Letter.
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Also as noted above, two commenters asked the Commission to provide
additional guidance about the control objectives that should be met to
achieve effective internal control over compliance with the financial
responsibility rules.\147\ As stated in the proposing release, the
control objectives identified in the Commission's guidance on Rule
206(4)-2 are more general than the specific operational requirements in
the financial responsibility rules.\148\ In particular, broker-dealers
are subject to operational requirements with respect to handling and
accounting for customer assets.\149\ Given the specificity of the
financial responsibility rules, the Commission does not believe that
additional guidance about the control objectives is necessary.
---------------------------------------------------------------------------
\147\ See Angel Letter; Deloitte Letter.
\148\ See Broker-Dealer Reports, 76 FR at 37580.
\149\ Id.
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As noted above, several commenters sought assurances that the
independent public accountant's examination of the compliance report
would not cover the effectiveness of internal control over financial
reporting.\150\ The final rule does not require that the broker-dealer
include a statement regarding the effectiveness of its internal control
over financial reporting, nor does it require that the independent
public accountant attest to the effectiveness of internal control over
financial reporting. The requirement in the final rule is for the
broker-dealer to state whether its Internal Control Over Compliance was
effective during the most recent fiscal year and at the end of the
fiscal year and for the accountant to express an opinion based on an
examination of those statements.
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\150\ See Deloitte Letter; KPMG Letter; PWC Letter.
---------------------------------------------------------------------------
A broker-dealer's Internal Control Over Compliance is intended to
focus, for example, on a broker-dealer's oversight of custody
arrangements and protection of customer assets. In contrast, internal
control over financial reporting is focused on the reliability of
financial reporting and the preparation of financial statements in
accordance with GAAP. As stated in the proposing release, the
Commission did not propose that effectiveness of internal control over
financial reporting be included as one of the assertions made by the
broker-dealer in the compliance report. The Commission intends that the
compliance report should focus on oversight of net capital, custody
arrangements, and protection of customer assets, and therefore, should
be focused on compliance with the financial responsibility rules.
Further, the examination of the compliance report would pertain
solely to certain statements in the compliance report and not to the
broker-dealer's process for arriving at the statements. The report of
the independent public accountant, based on the examination of the
compliance report, requires the accountant to perform its own
independent examination of the related internal controls. Consequently,
it is not necessary for the independent public accountant to provide an
opinion with regard to the process that the broker-dealer used to
arrive at its conclusions.
As noted above, commenters sought clarification of the meaning of
``books and records'' as used in the compliance report statement. The
reference in paragraph (d)(3)(i)(A)(5) of Rule 17a-5 to books and
records refers to the books and records a broker-dealer is required to
make and maintain under Commission rules (e.g., Rule 17a-3 and Rule
17a-4).\151\
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\151\ See 17 CFR 240.17a-3; 17 CFR 240.17a-4.
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4. The Exemption Report--Paragraph (d)(4) of Rule 17a-5
i. Proposed Amendments
The Commission proposed that the exemption report must contain an
assertion by the broker-dealer that it is exempt from Rule 15c3-3
because it meets conditions set forth in paragraph (k) of Rule 15c3-3
and ``should identify
[[Page 51921]]
the specific conditions.'' \152\ As discussed below in section II.D.3.
of this release, under the proposal, the independent public accountant,
as part of the engagement, would have been required to prepare a report
based on a review of the exemption report in accordance with PCAOB
standards.\153\
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\152\ See Broker-Dealer Reports, 76 FR at 37580-37581.
\153\ Id. at 37578-37579. PCAOB standards for attestation
engagements provide that accountants ordinarily should obtain
written assertions in an examination or review engagement.
---------------------------------------------------------------------------
ii. Comments Received
The Commission received several comments regarding the exemption
report.\154\ Some commenters stated that the Commission should clarify
whether the assertion would cover the entire fiscal year or be as of a
fixed date.\155\ One commenter stated that the assertion should be as
of a fixed date.\156\ With respect to the independent public
accountant's review of the exemption report, one commenter provided the
example of a bank or clerical error that results in a broker-dealer
that operates under an exemption to Rule 15c3-3 finding itself in
possession of customer assets overnight once during the fiscal
year.\157\ This commenter stated that such a situation should not
``warrant the `material modification' of a broker-dealer's Exemption
Report.'' \158\ Similarly, another commenter noted that ``to consider a
single instance of a broker-dealer failing to promptly forward a
customer's securities as an instance that would necessitate a material
modification creates an unworkable standard.'' \159\
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\154\ See CAQ Letter; Deloitte Letter; Grant Thornton Letter;
KPMG Letter. Some of the comments relating to the exemption report
and the response to the comments are discussed above in section
II.B.1. of this release.
\155\ See CAQ Letter; Deloitte Letter; Grant Thornton Letter;
KPMG Letter.
\156\ See KPMG Letter.
\157\ See SIFMA Letter.
\158\ Id.
\159\ See CAI Letter.
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One commenter stated that the exemption report relates only to Rule
15c3-3 and asked how the Commission intended to assess, for a firm that
claims an exemption from Rule 15c3-3, compliance with Rule 15c3-1 and
the adequacy of the firm's internal control over compliance with that
rule.\160\ Another commenter asked whether the exemption report should
be replaced with a box to check on the FOCUS Report, as the amount of
paperwork involved for small firms ``seems rather excessive.'' \161\
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\160\ See McGladrey Letter.
\161\ See Angel Letter.
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iii. The Final Rule
The Commission is adopting, with modifications discussed below, the
requirements regarding the exemption report.\162\ The modifications are
designed to address commenters' concerns that the proposed exemption
report assertion would create an unworkable standard given the
possibility that a broker-dealer might have instances of exceptions to
meeting the exemption provisions in paragraph (k) of Rule 15c3-3 and
that the proposed requirements with respect to the exemption report did
not explicitly provide how exceptions should be treated. In response to
these concerns, the final rule provides that exemption reports must
contain the following statements made to the best knowledge and belief
of the broker-dealer: (1) A statement that identifies the provisions in
paragraph (k) of Rule 15c3-3 under which the broker-dealer claimed an
exemption from Rule 15c3-3; (2) a statement the broker-dealer met the
identified exemption provisions in paragraph (k) of Rule 15c3-3
throughout the most recent fiscal year without exception or that it met
the identified exemption provisions in paragraph (k) of Rule 15c3-3
throughout the most recent fiscal year except as described in the
exemption report; and (3) if applicable, a statement that identifies
each exception during the most recent fiscal year in meeting the
identified provisions in paragraph (k) of Rule 15c3-3 and that briefly
describes the nature of each exception and the approximate date(s) on
which the exception existed.\163\
---------------------------------------------------------------------------
\162\ See paragraph (d)(4) of Rule 17a-5.
\163\ Id.
---------------------------------------------------------------------------
In response to comments seeking clarity as to whether the assertion
in the exemption report should cover a fixed date or the fiscal
year,\164\ the final rule explicitly provides that the statement and
certain information in the exemption report must cover the most recent
fiscal year.\165\ This corresponds to the provisions of paragraph
(d)(1)(i)(B) of Rule 17a-5 governing when a broker-dealer must file the
exemption report instead of the compliance report. In particular, a
broker-dealer that claimed an exemption from Rule 15c3-3 throughout the
most recent fiscal year must file the exemption report.\166\
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\164\ See CAQ Letter; Deloitte Letter; Grant Thornton Letter;
KPMG Letter.
\165\ See paragraph (d)(4)(ii) of Rule 17a-5.
\166\ See paragraph (d)(1)(i)(B) of Rule 17a-5.
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In addition, as proposed, the exemption report was required to
contain an assertion that the broker-dealer ``is exempt from the
provisions'' of Rule 15c3-3 ``because it meets conditions set forth
in'' paragraph (k) of Rule 15c3-3 and ``should identify the specific
conditions.'' \167\ Thus, the exemption report would have required the
broker-dealer to state definitively that ``it is exempt'' from Rule
15c3-3 because it ``meets the conditions set forth in'' in paragraph
(k).\168\ As noted above, commenters raised questions and concerns
about how certain exceptions would be handled under the proposed
exemption report requirements. The final rule addresses these comments
in a number of ways.
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\167\ See Broker-Dealer Reports, 76 FR at 37604.
\168\ Id.
---------------------------------------------------------------------------
First, it provides that the statements in the exemption report must
be made to the ``best knowledge and belief of the broker or dealer.''
\169\ This modification is designed to address situations where the
broker-dealer is unaware of an instance or instances in which it had an
exception to meeting the exemption provisions in paragraph (k) of Rule
15c3-3 during the most recent fiscal year. As discussed below, the
broker-dealer must state in the report that it met the exemption
provisions throughout the year without exceptions or with exceptions
that must be identified.\170\
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\169\ See paragraph (d)(4) of Rule 17a-5.
\170\ As discussed above in section II.B.3. of this release, a
carrying broker-dealer must state in the compliance report whether
it was in compliance with Rule 15c3-1 and paragraph (e) of Rule
15c3-3 as of the end of the most recent fiscal year. See paragraph
(d)(3)(i)(A)(4) of Rule 17a-5. In response to comments and in light
of the nature of the statements required in the exemption report,
the Commission added the best knowledge and belief standard to the
exemption report requirement.
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Second, the final rule provides that the broker-dealer first must
identify in the exemption report the ``provisions'' in paragraph (k) of
Rule 15c3-3 under which it ``claimed'' an exemption from Rule 15c3-
3.\171\ As discussed above in section II.B.1. of this release, the
final rule has been modified to provide that a broker-dealer must file
the exemption report if it did ``claim that it was exempt'' from Rule
15c3-3 throughout
[[Page 51922]]
the most recent fiscal year.\172\ This change is designed to remove any
ambiguity as to when a broker-dealer must file the exemption report as
opposed to the compliance report, particularly in situations where the
broker-dealer had exceptions to meeting the exemption provisions in
paragraph (k) of Rule 15c3-3. Consistent with this change, the final
rule requires the broker-dealer to identify in the exemption report the
provisions in paragraph (k) under which it ``claimed the
exemption.''\173\
---------------------------------------------------------------------------
\171\ See paragraph (d)(4)(i) of Rule 17a-5. As proposed,
paragraph (d)(4) of Rule 17a-5 provided that the exemption report
``shall contain a statement by the broker or dealer that it is
exempt from the provisions of [Rule 15c3-3] because it meets the
conditions set forth in [paragraph (k) of Rule 15c3-3] and should
identify the specific conditions.'' See Broker-Dealer Reports, 76 FR
37604 (emphasis added). The Commission intended that the broker-
dealer be required to identify the provisions of paragraph (k) of
Rule 15c3-3 under which the broker-dealer was claiming the
exemption. To make clear that this requirement and the other
requirements of the exemption report are mandatory, the final rule
uses the word ``must'' in relation to each element of the exemption
report. See paragraph (d)(4) of Rule 17a-5.
\172\ See paragraph (d)(1)(i)(B)(2) of Rule 17a-5. A broker-
dealer claiming an exemption from Rule 15c3-3 is required to
indicate the basis for the exemption on the periodic reports it
files with securities regulators. See, e.g., Item 24 of Part IIa of
the FOCUS Reports. See 17 CFR 249.617.
\173\ See paragraph (d)(4)(i) of Rule 17a-5.
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Further, as proposed, the broker-dealer would have been required to
identify the exemption ``conditions'' in paragraph (k) of Rule 15c3-
3.\174\ The use of the word ``provisions'' in the final rule is
designed to eliminate a potential ambiguity as to whether the exemption
provisions in paragraphs (k)(2) and (3) of Rule 15c3-3 applied to the
exemption report. In particular, paragraph (k) of Rule 15c3-3
prescribes ``exemptions'' from the requirements of Rule 15c3-3.\175\
Paragraph (k)(1) provides that the requirements of Rule 15c3-3 do not
apply to a broker-dealer that meets all of the ``conditions'' set forth
in the paragraph.\176\ Paragraph (k)(2) identifies two sets of
conditions (without using the word ``conditions'') either of which
exempts a broker-dealer from the requirements of Rule 15c3-3.\177\
Paragraph (k)(3) provides that the Commission may exempt a broker-
dealer from the provisions of Rule 15c3-3, either unconditionally or on
specified terms and conditions, if the Commission finds that the
broker-dealer has established safeguards for the protection of funds
and securities of customers comparable with those provided for by Rule
15c3-3 and that it is not necessary in the public interest or for the
protection of investors to subject the particular broker-dealer to the
provisions of Rule 15c3-3.\178\ The Commission intended that a broker-
dealer file an exemption report if it is exempt from Rule 15c3-3 under
the provisions in either paragraph (k)(1), (k)(2)(i), (k)(2)(ii), or
(k)(3) of Rule 15c3-3. To make this clear, the final rule refers to the
``provisions'' of paragraph (k) of Rule 15c3-3.\179\ Consequently, a
broker-dealer filing the exemption report must identify the provisions
in paragraph (k) that it relied on to claim an exemption from Rule
15c3-3.\180\
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\174\ See paragraph (d)(4)(ii) of Rule 17a-5. The proposed rule
provided that the broker-dealer must assert that it is exempt from
the provisions of Rule 15c3-3 because it meets ``conditions'' set
forth in paragraph (k) and should identify the specific
``conditions.'' See Broker-Dealer Reports, 76 FR at 37580-37581.
\175\ See 17 CFR 240.15c3-3(k)(1), (k)(2)(i), (k)(2)(ii), and
(k)(3).
\176\ See 17 CFR 240.15c3-3(k)(1)(i)-(iv).
\177\ See 17 CFR 240.15c3-3(k)(2)(i)-(ii).
\178\ See 17 CFR 240.15c3-3(k)(3).
\179\ This modification is consistent with Item 24 of Part IIa
of the FOCUS Report, which is titled ``EXEMPTIVE PROVISION UNDER
RULE 15c3-3'' and requires a broker-dealer that claims to be exempt
from the requirements of Rule 15c3-3 to identify the provision in
Rule 15c3-3--paragraph (k)(1), paragraph (k)(2)(i), paragraph
(k)(2)(ii), or paragraph (k)(3)--under which it is claiming to be
exempt. See 17 CFR 249.617.
\180\ This change also is intended to make clear that the
broker-dealer can identify the provisions of paragraph (k) of Rule
15c3-3 that the broker-dealer is relying on to claim the exemption
by simply identifying in the exemption report the subparagraph in
paragraph (k) (i.e., (k)(1), (k)(2)(i), (k)(2)(ii), or (k)(3)) that
contains the particular conditions the broker-dealer is relying on
to claim the exemption rather than repeating the conditions
themselves in the exemption report. For example, it would be
sufficient for a broker-dealer relying on the exemption provisions
in paragraph (k)(2)(ii) of Rule 15c3-3 to identify the provisions in
the exemption report under which in claimed an exemption by
referring to ``paragraph (k)(2)(ii) of Rule 15c3-3'' or ``17 CFR
240.15c3-3(k)(2)(ii).''
---------------------------------------------------------------------------
The third modification designed to address commenters' questions
and concerns about how to handle exceptions to meeting the exemption
provisions in paragraph (k) of Rule 15c3-3 relates to the proposed
assertion that the broker-dealer ``is exempt from the provisions'' of
Rule 15c3-3 ``because it meets conditions set forth in'' paragraph (k).
The final rule provides that the exemption report must contain a
statement that the broker-dealer met the identified exemption
provisions in paragraph (k) of Rule 15c3-3 throughout the most recent
fiscal year without exception or that it met the identified exemption
provisions in paragraph (k) of Rule 15c3-3 throughout the most recent
fiscal year except as described in the exemption report.\181\ This
modification from requiring the broker-dealer to state an absolute
(i.e., that it is exempt from Rule 15c3-3) allows the broker-dealer to
account for instances in which it had exceptions to meeting the
exemption provisions in paragraph (k) of Rule 15c3-3 directly in the
exemption report (rather than having to file the compliance report).
Specifically, if to the broker-dealer's best knowledge and belief, it
had no exceptions during the most recent fiscal year to the identified
exemption provisions in paragraph (k) of Rule 15c3-3, it must state in
the exemption report that it met the identified exemption provisions in
paragraph (k) without exception. Alternatively, a broker-dealer that
had exceptions must state that it met the identified exemption
provisions except as described in the exemption report.
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\181\ See paragraph (d)(4)(ii) of Rule 17a-5.
---------------------------------------------------------------------------
If the broker-dealer states that it had exceptions (e.g.,
exceptions identified during the year, such as through routine
monitoring of its compliance processes as part of the execution of its
internal controls, internal or external audits, or regulatory
examinations), the final rule requires the firm to identify, to its
best knowledge and belief, each exception and briefly describe the
nature of the exception and the approximate date(s) on which the
exception existed.\182\ The Commission expects that non-carrying
broker-dealers generally track exceptions as part of monitoring
compliance with the exemption provisions in paragraph (k) of Rule 15c3-
3.\183\ Further, a non-carrying broker-dealer's adherence to the
exemption provisions in paragraph (k) of Rule 15c3-3 generally is a
focus of Commission examiners when they conduct financial
responsibility examinations on this class of firm. For example,
examiners will review whether a non-carrying broker-dealer promptly
forwards checks in accordance with provisions in paragraph (k) of Rule
15c3-3. The Commission also notes that the 2011 AICPA Broker Dealer
Audit Guide states: ``In auditing the financial statements of a broker-
dealer claiming exemption from SEC Rule 15c3-3, the auditor should
determine whether and to what extent the broker-dealer complied with
the specific exemption during the audit period as well as the quality
of the broker-dealer's controls and procedures to ensure ongoing
compliance.''\184\ In addition, under the PCAOB's proposed standards,
the independent public accountant should inquire of individuals at the
broker-dealer who have relevant knowledge of controls relevant to the
broker-dealer's compliance with the exemption provisions and who are
responsible for monitoring compliance with the exemption provisions
whether they are aware of any deficiencies in controls over compliance
or instances of non-compliance with the exemption conditions.\185\
Moreover, in the independent public accountant's report, ``[i]f the
broker's or dealer's statement is not fairly stated, in all material
respects,
[[Page 51923]]
because of an instance or certain instances of non-compliance with the
exemption conditions, the auditor must modify the review report to
describe those instances of non-compliance and state that the broker or
dealer is not in compliance with the specified exemption conditions.''
\186\
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\182\ See paragraph (d)(4)(iii) of Rule 15c3-3.
\183\ See, e.g., Net Capital Rule, Exchange Act Release No.
31511 (Nov. 24, 1992), 57 FR 56973 (Dec. 2, 1992), at 56981 n.25
(stating that non-carrying broker-dealers must develop procedures to
ensure that they do not receive customer securities or checks made
payable to themselves).
\184\ See AICPA Broker-Dealer Audit Guide at ] 3.35.
\185\ See PCAOB Proposing Release app. 2 at ] 10.
\186\ Id. at ] 20.
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Under the final rule, a non-carrying broker-dealer must identify in
the exemption report and describe each exception during the most recent
fiscal year in meeting the identified exemption provisions in paragraph
(k) of Rule 15c3-3. The description must include the approximate
date(s) on which the exception existed. Without such reporting, the
Commission and the broker-dealer's DEA would have no information to
assess the nature, extent, and significance of the exceptions.
As noted above, one commenter asked whether the exemption report
should be replaced with a box to check on the FOCUS Report, as the
amount of paperwork involved for small firms ``seems rather
excessive.'' \187\ The Commission does not believe this is an
appropriate alternative. First, as indicated above, a broker-dealer
claiming an exemption from Rule 15c3-3 already is required to indicate
the basis for the exemption on its FOCUS Report.\188\ Second, the
exemption report requires the broker-dealer to make certain statements
that the independent public accountant must review. Thus, the exemption
report will provide a standardized statement across all broker-dealers
claiming an exemption from Rule 15c3-3 for the independent public
accountant to review. Third, the exemption report will provide the
Commission and the broker-dealer's DEA with more information than
currently is reported by non-carrying broker-dealers in the FOCUS
Report. Specifically, it requires the broker-dealer to, among other
things, state either that it met the identified exemption provisions in
paragraph (k) throughout the most recent fiscal year without exception
or that it met the identified exemption provisions throughout the most
recent fiscal year except as described in the report. This will provide
the Commission and the broker-dealer's DEA with information as to
whether a broker-dealer is meeting the exemption provisions of
paragraph (k) of Rule 15c3-3 (not simply that the broker-dealer is
claiming the exemption as is reported in the FOCUS Report). Fourth,
requiring that the exemption report be filed with the Commission should
increase broker-dealers' focus on the statements being made,
facilitating consistent compliance with the exemption provisions in
Rule 15c3-3, and therefore, providing better protection of customer
assets. Fifth, the requirement to prepare and file the exemption report
should not result in excessive paperwork, as stated by one
commenter.\189\
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\187\ See Angel Letter.
\188\ See Item 24 of Part IIa of the FOCUS Report.
\189\ See Angel Letter. The commenter did not explain why the
exemption report would result in excessive paperwork. Id. See also
discussion below in section VI.D.1.iii. of this release for the
estimated paperwork hour burden associated with this requirement.
---------------------------------------------------------------------------
As noted above, one commenter pointed out that the exemption report
relates solely to Rule 15c3-3 and asked how the adequacy of a non-
carrying broker-dealer's internal controls over compliance with Rule
15c3-1 would be assessed.\190\ Under the final amendments, a broker-
dealer's financial report will continue to include a supporting
schedule containing a net capital computation under Rule 15c3-1, which
will be covered by the independent public accountant's examination of
the financial report. Moreover, the PCAOB has proposed standards for
auditing supplemental information accompanying audited financial
statements.\191\
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\190\ See McGladery Letter. The material inadequacy report--
which applied to carrying and non-carrying broker-dealers--covered
Rule 15c3-1. See 17 CFR 240.17a-5(g).
\191\ See Proposed Auditing Standard, Auditing Supplemental
Information Accompanying Audited Financial Statements and Related
Amendments to PCAOB Standards, PCAOB Release No. 2011-05, PCAOB
Rulemaking Docket Matter No. 036 (July 12, 2011) (``PCAOB Proposed
Auditing Standard for Supplemental Information'').
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5. Time for Filing Annual Reports--Paragraph (d)(5) of Rule 17a-5
Prior to today's amendments, paragraph (d)(5) of Rule 17a-5
required that the annual audit report be filed not more than 60 days
after the date of the financial statements.\192\ The Commission
proposed amending paragraph (d)(5) to replace the term annual audit
report with annual reports.\193\ This change was designed to reflect
the fact that, under the proposal, broker-dealers must file a financial
report, a compliance report or exemption report, and reports prepared
by an independent public accountant covering these reports. While the
Commission did not receive comments on this proposed change, one
commenter stated that the existing requirement in Rule 17a-5 that the
annual audit report be filed 60 days after the date of the financial
statements should be lengthened to 90 days.\194\ In support of this
recommendation, the commenter cited CFTC Rule 1.10, which allows an FCM
up to 90 days to file annual audit reports.\195\
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\192\ See 17 CFR 240.17a-5(d)(5).
\193\ See Broker-Dealer Reports, 76 FR at 37604.
\194\ See IMS Letter.
\195\ See 17 CFR 1.10(b)(ii). Rule 1.10 also provides that if
the FCM is registered with the Commission as a broker-dealer, the
FCM must file the report not later than the time permitted for
filing an annual audit report under Rule 17a-5.
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The Commission is adopting, with modifications, the proposed
amendment to paragraph (d)(5) of Rule 17a-5.\196\ The modifications add
the term ``calendar'' to make explicit that the time for filing the
annual reports is 60 calendar days after the fiscal year end (as
opposed to business days). The modifications replace the words ``date
of the financial statements'' with the words ``end of the fiscal year
of the broker or dealer'' to provide consistency in the language of
Rule 17a-5.\197\ The final rule does not change the time limit for
filing the annual reports to 90 days after the end of the fiscal year.
The 60-day time frame is a long standing requirement and it provides
the Commission and other regulators with relatively current information
to, among other things, monitor the financial condition of broker-
dealers. Further, broker-dealers may seek an extension of time to file
the annual reports from their DEAs.\198\
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\196\ See paragraph (d)(5) of Rule 17a-5.
\197\ Id. See also paragraph (n) of Rule 17a-5.
\198\ See paragraph (m) of Rule 17a-5.
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6. Filing of Annual Reports With SIPC--Paragraph (d)(6) of Rule 17a-5
Prior to today's amendments, paragraph (d)(6) of Rule 17a-5
provided that the ``annual audit report'' must be filed at the regional
office of the Commission for the region in which the broker-dealer has
its principal place of business, the Commission's principal office in
Washington, DC, and the principal office of the DEA of the broker-
dealer.\199\ Copies were required to be provided to all self-regulatory
organizations (``SROs'') of which the broker-dealer is a member.
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\199\ See 17 CFR 240.17a-5(d)(6).
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i. The Proposed Amendments
The Commission proposed two amendments to this provision. First,
the Commission proposed that an SRO that is not a broker-dealer's DEA
could by rule waive the requirement that broker-dealers file annual
reports with it because many SROs do not believe that it is necessary
to receive copies of broker-dealer annual reports if they are not the
broker-dealer's DEA.\200\ The
[[Page 51924]]
Commission received no comments on this proposal and is adopting it as
proposed.\201\
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\200\ See Broker-Dealer Reports, 76 FR at 37592.
\201\ See paragraph (d)(6) of Rule 17a-5.
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Second, the Commission proposed amending this provision to require
a broker-dealer to file its annual reports with SIPC.\202\ SIPC, a
nonprofit, nongovernmental membership corporation established by SIPA,
is responsible for providing financial protection to customers of
failed broker-dealers. SIPA also provided for the establishment of a
fund (``SIPC Fund'') to pay for SIPC's operations and activities. SIPC
uses the fund to make advances to satisfy customer claims for
securities and cash that cannot be readily returned to the customer.
SIPA limits the amount of the advance to $500,000 per customer, of
which $250,000 can be used to satisfy the cash portion of a customer's
claim. The SIPC Fund also covers the administrative expenses of
liquidation proceedings for failed broker-dealers when the general
estate of the failed firm is insufficient; these include costs incurred
by a trustee, trustee's counsel, and other advisors. SIPC finances the
SIPC Fund through annual assessments, set by SIPC, on all member firms,
plus interest generated from its permitted investments. Generally, all
broker-dealers registered with the Commission under section 15(b) of
the Exchange Act \203\ are required to be members of SIPC.\204\ Before
today's amendments, broker-dealers were required to file only limited
information with SIPC. Specifically: (1) Information elicited on Form
SIPC-6, the ``General Assessment Payment Form;'' (2) information
elicited on Form SIPC-7, the ``Annual General Assessment
Reconciliation;'' and (3) for periods in which the SIPC assessment is
not a minimum assessment, a comparison by the independent public
accountant of the amounts reflected in the annual report the broker-
dealer filed with the Commission with amounts reported on Form SIPC-7.
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\202\ See Broker-Dealer Reports, 76 FR at 37592.
\203\ See 15 U.S.C. 78o(b).
\204\ See 15 U.S.C. 78ccc(a)(2). However, broker-dealers engaged
exclusively in the distribution of mutual fund shares, the sale of
variable annuities, the insurance business, the furnishing of
investment advice to investment companies or insurance company
separate accounts, or whose principal business is conducted outside
the U.S. are not required to be members of SIPC. See 15 U.S.C.
78ccc(a)(2)(A)(i)-(iii).
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The Commission explained in the proposing release that the proposed
requirement for broker-dealers to file their annual reports with SIPC
could allow SIPC to better monitor industry trends and enhance its
knowledge of particular firms.\205\ The Commission also explained that
the requirement that broker-dealers file copies of their annual reports
with SIPC was designed to address cases where the SIPC Fund has been
used to pay the administrative expenses of the liquidation of a failed
broker-dealer and SIPC sought to recover the money advanced when the
estate had insufficient assets.\206\ In some of these cases, SIPC has
sought to recover money damages from the broker-dealer's auditing firm
based on an alleged failure to comply with auditing standards. At least
one court, however, has held under New York law that SIPC could not
maintain such a claim because it was not a recipient of the annual
audit filing and could not have relied on it.\207\
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\205\ See Broker-Dealer Reports, 76 FR at 37592.
\206\ Id. See also SIPC, 2010 Annual Report, at 18, available at
https://www.sipc.org/pdf/2010%20Annual%20Report.pdf.
\207\ See SIPC v. BDO Seidman, LLP, 746 NE.2d 1042 (N.Y. 2001).
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ii. Comments Received
The Commission received seven comments on the proposal that broker-
dealers be required to file their annual reports with SIPC.\208\ Six
commenters generally opposed the requirement.\209\ One commenter
indicated that it is appropriate for broker-dealers to file their
annual reports with SIPC if SIPC uses the reports to reconcile the
annual reports with the Form SIPC-7 or otherwise places reliance on
them.\210\ Three of the commenters stated that the Commission failed to
adequately articulate the policy considerations driving the proposed
change and also failed to discuss the possible costs of increased
litigation risk to accountants.\211\ Some of the commenters argued that
this change would contradict limitations on SIPC's authority to bring
claims against accountants under SIPA and the securities laws imposed
by the U.S. Supreme Court.\212\
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\208\ See CAQ Letter; Deloitte Letter; E&Y Letter; Grant
Thornton Letter; KPMG Letter; McGladrey Letter; PWC Letter.
\209\ See CAQ Letter; Deloitte Letter; E&Y Letter; Grant
Thornton Letter; KPMG Letter; PWC Letter.
\210\ See McGladrey Letter. Form SIPC-7 is discussed in more
detail below in section II.C.4. of this release.
\211\ See CAQ Letter; Deloitte Letter; KPMG Letter.
\212\ See CAQ Letter; Deloitte Letter; E&Y Letter; KPMG Letter;
PWC Letter.
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After the proposal, a task force established by SIPC to undertake a
comprehensive review of SIPA and SIPC's operations and policies and to
propose reforms to modernize SIPA and SIPC recommended to the SIPC
Board that SIPC members be required to file audit reports with SIPC
concurrently with their filing with the SEC, a position consistent with
the proposal. In a report presented to the SIPC Board of Directors in
February 2012,\213\ the task force stated that including SIPC as a
designated recipient of the audit report ``would further the goal of
investor protection by providing another layer of review of the report
by an organization directly affected by its contents.'' \214\ In
addition, the task force stated that ``including SIPC as a recipient
would help to address the persistent concern that any signs of
`financial weakness, as by non-compliance with net capital requirements
or otherwise, [be] watched very carefully and followed up' in order to
augment the financial responsibility requirements SIPA was intended to
enhance, and to provide greater investor protection.'' \215\
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\213\ See Report and Recommendations of the SIPC Modernization
Task Force (Feb. 2012), available at https://www.sipc.org/pdf/Final%Report%202012.pdf. The Task Force was comprised of volunteers,
and included investor advocates, regulatory specialists, and
academic experts, including the trustee for the liquidation of
Lehman Brothers Inc. and MF Global Inc.
\214\ See Report and Recommendations of the SIPC Modernization
Task Force, at 19.
\215\ Id. (quoting the SEC, Study of Unsafe and Unsound
Practices of Broker-Dealers, H.R. Doc. No. 92-231, at 152 (1971)).
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iii. The Final Rule
The Commission is adopting the amendment requiring broker-dealers
to file their annual reports with SIPC substantially as proposed.\216\
SIPC plays an important role in the securities markets and the SIPC
Fund can help reduce losses to investors from the failure of their
broker-dealer. SIPC has a legitimate interest in receiving the annual
reports of its broker-dealer members to assist it with its maintenance
of the SIPC Fund and to monitor trends in the broker-dealer industry.
SIPC presently obtains revenue information from broker-dealers, through
Form SIPC-7, to determine how best to structure broker-dealer
assessments to maintain the SIPC Fund at an appropriate level. However,
the information collected in the form is limited and may not assist
SIPC in assessing whether the SIPC Fund is appropriately sized to the
risks of a large broker-dealer failure. The annual audited reports
contain much more detailed information about the assets, liabilities,
income, net capital, and Rule
[[Page 51925]]
15c3-3 customer reserve requirements of broker-dealers, and also
include, for carrying broker-dealers, a compliance report containing
information about the broker-dealer's compliance with, and controls
over compliance with, the broker-dealer financial responsibility rules.
The annual reports also generally include the independent public
accountant's reports covering the financial report and compliance
report or exemption report, as applicable, prepared by the broker-
dealer. This information will assist SIPC in monitoring the financial
strength of broker-dealers and, therefore, in assessing the adequacy of
the SIPC Fund.\217\
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\216\ See paragraph (d)(6) of Rule 17a-5. The Commission
clarified that the broker-dealer must file the annual reports with
SIPC only ``if the broker or dealer is a member of SIPC.'' The
Commission believes that SIPC has an interest in receiving annual
reports only from broker-dealers that are SIPC members, because only
these broker-dealers may pose a risk to the SIPC Fund.
\217\ See McGladrey Letter.
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In addition, by receiving the annual reports, SIPC may be able to
overcome a legal hurdle to pursuing claims against a broker-dealer's
accountant where the accountant's failure to adhere to professional
standards in auditing a broker-dealer caused a loss to the SIPC Fund.
Although this amendment is intended to remove one potential legal
hurdle to SIPC actions against accountants, the other elements of any
relevant cause of action would be unaffected. The Commission does not
intend by this amendment to take a position on the circumstances under
which SIPC may have a viable cause of action against an independent
public accountant.\218\
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\218\ Several commenters argue that requiring the annual report
to be filed with SIPC would contradict limitations the Supreme Court
has imposed on SIPC's authority to bring claims against accountants.
The decisions cited by these commenters, however, do not speak to
the precise issue the amended rule is intended, among other things,
to address--the New York Court of Appeals' decision held that SIPC
could not state a cause of action for either fraudulent or negligent
misrepresentation against an auditing firm because it was not a
recipient of the annual audit report. See SIPC v. BDO Seidman, LLP,
746 NE.2d 1042 (N.Y. 2001); aff'd, 245 F.3d 174 (2d Cir. 2001).
Rather, in Holmes v. Securities Investor Protection Corporation, the
Supreme Court found that the statutory provision relied on by SIPC,
15 U.S.C. 78eee(d), did not, either alone or with the Racketeer
Influenced and Corrupt Organizations Act, confer standing. 503 U.S.
258, 275 (1992). And, in Touche Ross & Co. v. Redington, the Supreme
Court determined that customers of securities brokerage firms do not
have an implied cause of action for damages under section 17(a) of
the Exchange Act against accountants who audit the financial reports
filed by such firms; thus, SIPC could not assert this implied cause
of action on behalf of these customers. 442 U.S. 560, 567 (1979). As
already noted, the Commission does not intend by this amendment to
take a position on the circumstances under which SIPC may have a
viable cause of action against an independent public accountant.
---------------------------------------------------------------------------
Several commenters stated that the Commission did not address the
potential costs and benefits of requiring broker-dealers to file copies
of their annual reports with SIPC, including potential accounting
litigation costs.\219\ As discussed below in section VII. of this
release, the Commission recognizes that there may be increased
litigation costs (or reserves for potential litigation costs) as a
result of the amendment and that to the extent that there are such
costs, some of them may be passed on to broker-dealers in the form of
increased audit fees. But, while this amendment may facilitate the
ability of SIPC to bring actions against accountants for malpractice or
material misrepresentation under state law by removing one potential
legal hurdle to such actions, it will not necessarily result in a
significant increase in such actions. Generally, SIPC initiates a small
number of proceedings each year, and most of these proceedings have not
involved a claim against a broker-dealer's accountant. Specifically,
SIPC was established in 1971. In the period from 1971-2011, SIPC
initiated 324 proceedings under SIPA to liquidate a failed broker-
dealer.\220\ This results in an average of approximately 8 SIPA
proceedings per year, though 109 of the 324 proceedings were initiated
in the period from 1971-1974, which was the immediate aftermath of the
financial crisis of 1968-1970.\221\ According to SIPC staff, SIPC has
brought 9 lawsuits against accountants since 1971, which is one lawsuit
for every 36 SIPA proceedings.\222\ Accordingly, the likelihood of a
lawsuit against an accountant is small and the Commission anticipates
that the overall costs related to litigation as a result of the filing
requirement should not be significant. The Commission believes that any
such costs are justified by the benefits of enhanced customer
protection and the associated ability of SIPC to better assess the
financial condition of broker-dealers and the adequacy of the SIPC
Fund.
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\219\ See, e.g., CAQ Letter; Deloitte Letter; KPMG Letter.
\220\ See SIPC, Annual Report 2011, at 6.
\221\ Id. See also Commission, Study of Unsafe and Unsound
Practices of Brokers and Dealers: Report and Recommendations of the
Securities and Exchange Commission (December 1971) (discussing the
financial crisis of 1968-1970). Since its inception through 2001,
SIPC initiated 299 proceedings under SIPA.
\222\ See Redington v. Touche Ross & Co., 592 F.2d 617 (2d Cir.
1978); In re Bell & Beckwith, 77 B.R. 606 (Bkrtcy. N.D. Ohio, 1987);
Mishkin v. Peat, Marwick, Mitchell & Co., 658 F.Supp. 271 (S.D.N.Y.
1987); SIPC v. BDO Seidman, LLP, 49 F.Supp.2d 644 (S.D.N.Y. 1999);
In re Donahue Securities Inc., 2004 WL 3152763 (Bkrtcy S.D. Ohio,
2004); In re SIPC v. R.D. Kushnir & Co, 274 B.R. 768 (Bkrtcy. N.D.
Ill., 2002); In re Sunpoint Securities, Inc., 377 B.R. 513 (Bkrtcy.
E.D. Tex., 2007); Compliant at 5-6, Gilbert v. Ohab, Bkrtcy. M.D.
Fl. (May 2010) (No. 6:08-ap-00145-KSJ); Complaint at 2, Shively v.
Mortland, Bkrtcy. D. Co. (Feb. 2004) (No. 03-BK-1102-HRT).
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C. The Nature and Form of the Annual Reports
1. Exemptions From Audit Requirement--Paragraph (e)(1) of Rule 17a-5
Prior to today's amendments, paragraph (e)(1)(i) of Rule 17a-5
provided, among other things, that the audit of the broker-dealer's
financial statements needed to be performed by an accountant that is
independent as defined in paragraph (f) of Rule 17a-5.\223\ Paragraph
(e)(1)(i) also contained provisions under which certain broker-dealers
were not required to engage an accountant to audit their financial
statements.\224\
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\223\ See 17 CFR 240.17a-5(e)(1)(i).
\224\ Id.
---------------------------------------------------------------------------
The Commission proposed amending paragraph (e)(1)(i) of Rule 17a-5
to remove the words ``An audit shall be conducted by a public
accountant who shall be in fact independent as defined in paragraph
(f)(3) of this section herein, and he shall give an opinion covering
the statements filed pursuant to paragraph (d).'' This amendment would
consolidate the requirements with respect to the qualifications of the
accountant in paragraph (f) of Rule 17a-5, and paragraph (e)(1)(i) of
Rule 17a-5 would address only exemptions from the requirement to engage
an independent public accountant to audit the annual reports prepared
by the broker-dealer.\225\ The Commission received no comments on this
proposal, and is adopting it with modifications.\226\ The
modifications: (1) Modernize certain terms in the rule in a manner
consistent with the Commission's ``plain English'' initiative; and (2)
cite to the reports required under ``Rule 17a-5(d)(1)(i)(C)'' to
provide a more precise cross reference than the former citation to
reports required under ``Rule 17a-5(d).'' \227\
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\225\ See Broker-Dealer Reports, 76 FR at 37593-37594. The
proposed and final amendments to paragraph (f) of Rule 17a-5 are
discussed below in section II.E. of this release.
\226\ See paragraph (e)(1)(i) of Rule 17a-5.
\227\ Id. Prior to today's amendments, paragraph (e)(1)(ii) of
Rule 17a-5 provided that ``[a] broker or dealer who files a report
which is not covered by an accountant's opinion shall include in the
oath or affirmation required by paragraph (e)(2) of this section a
statement of the facts and circumstances relied upon as a basis for
exemption from the requirement that financial statements and
schedules filed pursuant to paragraph (d) of this section be covered
by the opinion of an accountant.'' See 17 CFR 240.17a-5(e)(1)(ii).
The Commission did not propose amendments to this subparagraph.
However, to be consistent with today's amendments, the Commission is
making technical amendments to paragraph (e)(1)(ii) of Rule 17a-5 so
that it now provides that ``[a] broker or dealer that files annual
reports under paragraph (d) of this section that are not covered by
reports prepared by an independent public accountant must include in
the oath or affirmation required by paragraph (e)(2) of this section
a statement of the facts and circumstances relied upon as a basis
for exemption from the requirement that the annual reports filed
under paragraph (d) of this section be covered by reports prepared
by an independent public accountant.'' See paragraph (e)(1)(ii) of
Rule 17a-5.
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[[Page 51926]]
2. Affirmation--Paragraph (e)(2) of Rule 17a-5
Prior to today's amendments, paragraph (e)(2) of Rule 17a-5
provided that an oath or affirmation must be attached to the annual
audit report that, to the best knowledge and belief of the person
making the oath or affirmation, the financial statements and schedules
are true and correct and, among other things, that the oath or
affirmation must be made by the proprietor if a sole proprietorship, by
a general partner, if a partnership, or by a duly authorized officer,
if a corporation.\228\ The Commission proposed amending the first
sentence of paragraph (e)(2) of Rule 17a-5 by adding the word
``financial'' before the word ``report.''\229\ The Commission is
adopting this amendment as proposed.
---------------------------------------------------------------------------
\228\ See 17 CFR 240.17a-5(e)(2).
\229\ See Broker-Dealer Reports, 76 FR at 37603.
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One commenter stated that currently paragraph (e)(2) of Rule 17a-5
does not specifically cover limited liability companies, and its
reference to partnerships assumes that a general partner is a natural
person.\230\ The commenter argued that it should be updated to conform
to generally accepted business laws.
---------------------------------------------------------------------------
\230\ See IMS Letter.
---------------------------------------------------------------------------
In response to this comment, the Commission is adopting amendments
to paragraph (e)(2) of Rule 17a-5 that modify the proposed
amendments.\231\ In particular, the Commission is adding that if the
broker-dealer is a limited liability company or limited liability
partnership, the oath or affirmation must be made by the chief
executive officer, chief financial officer, manager, managing member,
or any of those members vested with management authority for the
limited liability company or limited liability partnership.\232\
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\231\ See paragraph (e)(2) of Rule 17a-5.
\232\ See IMS Letter.
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3. Confidentiality of Annual Reports--Paragraph (e)(3) of Rule 17a-5
Prior to today's amendments, paragraph (e)(3) of Rule 17a-5
provided that the financial statements filed under paragraph (d) are
public, except that if the Statement of Financial Condition is bound
separately from the balance of the annual audited financial statements
filed under paragraph (d)(1), the balance of the annual audited
financial statements will be deemed confidential.\233\ As noted in the
proposing release, the wording of this provision has led to
confusion.\234\ In particular, Commission staff has received inquiries
on how broker-dealers can indicate that they are requesting
confidential treatment for the portion of the financial statements
intended to be kept confidential to the extent permitted by law and, on
occasion, financial statements broker-dealers intended to be
confidential are inadvertently made public.\235\ This could happen, for
example, if a broker-dealer fails to bind the balance sheet separately
from the other portion of the financial statements when it files the
financial statements with the Commission.\236\
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\233\ See 17 CFR 240.17a-5(e)(3).
\234\ See Broker-Dealer Reports, 76 FR at 37592-37593.
\235\ The public portions of broker-dealer annual audited
reports are available on the Commission's Web site. These reports
may be accessed via the Search for Company Filings link under
Filings & Forms on the Commission's home page.
\236\ The Commission staff has previously posted guidance on the
Commission Web site on how to request confidential treatment for the
financial statements other than the statement of financial
condition. See https://www.sec.gov/divisions/marketreg/bdnotices.htm.
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Consequently, the Commission proposed amending paragraph (e)(3) of
Rule 17a-5 to provide that the annual reports filed pursuant to
paragraph (d) are public, except that if the Statement of Financial
Condition is bound separately from the annual report filed pursuant to
``paragraph (d)(2) of Rule 17a-5,'' and each page of the balance of the
annual report is stamped ``confidential,'' the balance of the annual
report shall be deemed confidential.\237\ The proposed rule text
inadvertently referenced only the financial report. It was intended
that the financial report, compliance report, exemption report, and
related accountant reports would be treated the same under paragraph
(e)(3) of Rule 17a-5. Consequently, the Commission is modifying the
proposed amendment. Specifically, paragraph (e)(3) of Rule 17a-5, as
adopted, provides that if the Statement of Financial Condition is bound
separately from the balance of the ``annual reports filed under
paragraph (d) of this section,'' and each page of the balance of the
annual reports is stamped ``confidential,'' then the balance of the
annual reports will be deemed confidential to the extent permitted by
law.\238\ Consequently, if the compliance reports and exemption reports
and the related reports of the independent public accountant are
submitted in accordance with the procedures specified in paragraph
(e)(3) of Rule 17a-5, these reports will be deemed confidential to the
extent permitted by law.\239\
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\237\ See Broker-Dealer Reports, 76 FR at 37592-37593.
\238\ See paragraph (e)(3) of Rule 17a-5.
\239\ See 5 U.S.C. 552 et seq. (Freedom of Information Act--
``FOIA''). FOIA provides at least two potentially pertinent
exemptions under which the Commission has authority to withhold
certain information. FOIA Exemption 4 provides an exemption for
``trade secrets and commercial or financial information obtained
from a person and privileged or confidential.'' 5 U.S.C. 552(b)(4).
FOIA Exemption 8 provides an exemption for matters that are
``contained in or related to examination, operating, or condition
reports prepared by, on behalf of, or for the use of an agency
responsible for the regulation or supervision of financial
institutions.'' 5 U.S.C. 552(b)(8). However, as discussed below,
under paragraph (c)(2)(iv) of Rule 17a-5, if there are material
weaknesses, the accountant's report on the compliance report must be
made available for customers' inspection and, consequently, it would
not be deemed confidential. In addition, paragraph (c)(2)(i) of Rule
17a-5 (which is not being amended today) requires a broker-dealer to
furnish to its customers annually a balance sheet with appropriate
notes prepared in accordance with GAAP and which must be audited if
the broker-dealer is required to file audited financial statements
with the Commission. See 17 CFR 240.17a-5(c)(2)(i).
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Prior to today's amendments, paragraph (e)(3) of Rule 17a-5 also
provided that the broker-dealer's reports, including the confidential
portions, will be available, for example, for official use by any
official or employee of the U.S. and an official or employee of any
national securities exchange and registered national securities
association of which the broker-dealer is a member and ``by any other
person to whom the Commission authorizes disclosure of such information
as being in the public interest.'' \240\ The Commission proposed
amending this list of permitted recipients to include the PCAOB.\241\
The Commission did not receive comments on this proposal and is
adopting it essentially as proposed with a minor wording edit for
clarity.\242\
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\240\ See 17 CFR 240.17a-5(e)(3).
\241\ See Broker-Dealer Reports, 76 FR at 37592-37593.
\242\ See paragraph (e)(3) of Rule 17a-5.
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4. Supplemental Report on SIPC Membership--Paragraph (e)(4) of Rule
17a-5
As discussed above in section II.B.6. of this release, SIPC
maintains the SIPC Fund to be used in liquidations of broker-dealers
under SIPA. The SIPC Fund is established and maintained through
assessments on broker-dealers that are required to be members of
[[Page 51927]]
SIPC.\243\ In order to assist in the collection of assessments from
member broker-dealers, SIPC has promulgated two forms that broker-
dealers must file with SIPC, as applicable: Form SIPC-3 and Form SIPC-
7. Form SIPC-3 is required when a broker-dealer is claiming an
exemption from SIPC membership (i.e., when the broker-dealer does not
have to pay an assessment). In this case, the broker-dealer must file
Form SIPC-3 each year certifying that the broker-dealer remained
qualified for the exemption during the prior year. Form SIPC-7 elicits
information from a broker-dealer that is a SIPC member about the
broker-dealer's sources of revenue attributable to its securities
business. Every broker-dealer that is a member of SIPC must file this
form annually.
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\243\ Broker-dealers engaged exclusively in the distribution of
mutual fund shares, the sale of variable annuities, the insurance
business, the furnishing of investment advice to investment
companies or insurance company separate accounts, or whose principal
business is conducted outside the U.S. are not required to be
members of SIPC. See 15 U.S.C. 78ccc(a)(2)(A)(i)-(iii).
---------------------------------------------------------------------------
Prior to today's amendments, paragraph (e)(4) of Rule 17a-5
provided that a broker-dealer must file with its annual report a
supplemental report on the status of the membership of the broker-
dealer in SIPC, which was required to be ``covered by an opinion of the
independent public accountant'' if the annual report of the broker-
dealer was required to be audited.\244\ Among other things, the
supplemental report needed to cover the SIPC annual general assessment
reconciliation or exclusion from membership forms (i.e., Form SIPC-7 or
Form SIPC-3).\245\ Paragraph (e)(4)(iii) of Rule 17a-5 used the terms
``review'' and ``opinion'' in describing the accountant's report that
must cover the supplement report.\246\ In addition, it required that
the review by the accountant include certain minimum procedures.\247\
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\244\ See 17 CFR 240.17a-5(e)(4).
\245\ Id.
\246\ See 17 CFR 240.17a-5(e)(4)(iii).
\247\ See 17 CFR 240.17a-5(e)(4)(iii)(A)-(F).
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Under this provision, the supplemental report did not need to be
filed if the SIPC Fund assessments were the minimum assessment provided
for under SIPA.\248\ Between 1996 and 2009, the annual assessment for
SIPC members remained at the $150 minimum assessment level provided for
under SIPA.\249\ In 2009, SIPC raised the assessment above the minimum,
which triggered the requirement in paragraph (e)(4) of Rule 17a-5 to
file a supplemental report with the Commission, the broker-dealer's
DEA, and SIPC.\250\
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\248\ See 17 CFR 240.17a-5(e)(4); 15 U.S.C. 78ddd(d)(1)(c).
\249\ See SIPC, SIPC to Reinstitute Assessments of Member Firms'
Operating Revenues (Mar. 2, 2009) (news release).
\250\ Id.
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The Commission stated in the proposing release that, because Forms
SIPC-3 and SIPC-7 are used solely by SIPC for purposes of levying its
assessments, the supplemental report required pursuant to paragraph
(e)(4) of Rule 17a-5 relating to these forms would be more
appropriately filed exclusively with SIPC and that SIPC (rather than
the Commission) should prescribe by rule the form of the supplemental
report.\251\ The Commission stated that it would continue to have a
role in establishing the requirements for a supplemental report because
the Commission must approve SIPC rules.\252\
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\251\ See Broker-Dealer Reports, 76 FR at 37582.
\252\ Id.
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For these reasons, the Commission proposed to amend paragraph
(e)(4) of Rule 17a-5 to require that broker-dealers file with SIPC a
report on the SIPC annual general assessment reconciliation or
exclusion from membership forms that contains such information and is
in such format as determined by SIPC by rule and approved by the
Commission.\253\ However, because there would be an interim period
before a rule determined by SIPC became effective, the Commission
proposed amendments to paragraph (e)(4) under which broker-dealers
would continue to file a supplemental report with the Commission, the
broker-dealer's DEA, and SIPC until SIPC adopts a rule pursuant to
paragraph (e)(4)(i) of Rule 17a-5 and the rule is approved by the
Commission.\254\ Consequently, a broker-dealer would be required to
file the SIPC supplemental reports with SIPC using the existing formats
for the reports until the earlier of the Commission approving a rule
adopted by SIPC or two years. If after two years, a rule promulgated by
SIPC has not been approved by the Commission, broker-dealers would no
longer be required to file these reports.
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\253\ Id.
\254\ Id.
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Further, to facilitate this change, the Commission proposed to
update the rule text to conform it to existing professional standards
and industry practices.\255\ Specifically, the Commission proposed
amending paragraph (e)(4) of Rule 17a-5 to eliminate the ambiguity that
stems from the differing auditing terms used in that rule by removing
all references to ``review'' and ``opinion.'' \256\ In their place, the
Commission proposed that the supplemental report include an independent
public accountant's report based on the performance of the procedures
listed in paragraph (e)(4)(iii) of Rule 17a-5, which the Commission did
not propose to change.\257\
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\255\ Id.
\256\ Id.
\257\ See Broker-Dealer Reports, 76 FR at 37582. The Commission
proposed one modification to the procedures listed in former
paragraph (e)(4)(iii); namely, amending the procedure described in
paragraph (e)(4)(iii)(F), which is now renumbered (e)(4)(ii)(6), to
change the reference from ``Form SIPC-7'' to ``Form SIPC-3'' because
the reference to Form SIPC-7 is inaccurate. Id.
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The Commission received two comments relating to the proposed
amendments to paragraph (e)(4) of Rule 17a-5, both of which supported
the proposed change.\258\ One commenter indicated that the proposed
amendment would decrease the burden on broker-dealers associated with
filing the supplemental report with the Commission and the broker-
dealer's DEA.\259\ In addition, the other commenter indicated that
until the supplemental reports are filed exclusively with SIPC, they
should be subject to confidential treatment.\260\
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\258\ See CAI Letter; McGladrey Letter.
\259\ See CAI Letter.
\260\ See McGladrey Letter.
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The Commission is adopting the amendments to paragraph (e)(4) of
Rule 17a-5 as proposed.\261\ With respect to the comment about the
Commission keeping the supplemental report confidential, a broker-
dealer can request confidential treatment for the report.\262\ If such
a request is made, the Commission anticipates that it will accord the
supplemental report confidential treatment to the extent permitted by
law.\263\
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\261\ See paragraph (e)(4) of Rule 17a-5.
\262\ See 17 CFR 200.83. Information about how to request
confidential treatment of information submitted to the Commission is
available at https://www.sec.gov/foia/howfo2.htm#privacy.
\263\ See, e.g., Exchange Act section 24, 15 U.S.C. 78x
(governing the public availability of information obtained by the
Commission) and 5 U.S.C. 552 et seq. (Freedom of Information Act--
``FOIA''). FOIA provides at least two pertinent exemptions under
which the Commission has authority to withhold certain information.
FOIA Exemption 4 provides an exemption for ``trade secrets and
commercial or financial information obtained from a person and
privileged or confidential.'' 5 U.S.C. 552(b)(4). FOIA Exemption 8
provides an exemption for matters that are ``contained in or related
to examination, operating, or condition reports prepared by, on
behalf of, or for the use of an agency responsible for the
regulation or supervision of financial institutions.'' 5 U.S.C.
552(b)(8).
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[[Page 51928]]
D. Engagement of the Accountant
As part of today's amendments to the broker-dealer annual reporting
requirements in Rule 17a-5, the Commission is amending certain
requirements relating to a broker-dealer's engagement of an independent
public accountant. Specifically, the Commission is requiring that a
broker-dealer engage an independent public accountant to prepare
reports based on an examination of the broker-dealer's financial report
and either an examination of certain statements in the broker-dealer's
compliance report or a review of certain statements in the broker-
dealer's exemption report. The examinations and reviews must be made in
accordance with the standards of the PCAOB, consistent with the
explicit authority granted to the PCAOB by the Dodd-Frank Act to
establish (subject to Commission approval) auditing and attestation
standards with respect to broker-dealer audits.\264\ Among other
things, the amendments replace provisions that required the filing of a
``material inadequacy'' report and are intended to update terminology
in the rule to make the rule's requirements clear and to provide for a
more consistent approach to engaging broker-dealer independent public
accountants.
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\264\ See Public Law 111-203 Sec. 982.
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This section addresses statutory requirements for broker-dealer
annual reports and the Commission's authority with regard to these
reports, describes the engagement of accountant requirements in Rule
17a-5 prior to today's amendments, summarizes the Commission's proposed
amendments and comments received, and discusses the final rule
amendments.
1. Statutory Requirements and Commission Authority
Section 17(e)(1)(A) of the Exchange Act requires a broker-dealer to
file annually with the Commission a ``certified'' balance sheet and
income statement as well as ``such other financial statements (which
shall, as the Commission specifies, be certified) and information
concerning its financial condition as the Commission, by rule, may
prescribe as necessary or appropriate in the public interest or for the
protection of investors.'' \265\ Section 17(e)(2) of the Exchange Act
provides the Commission with authority, by rule, to prescribe the form
and content of the financial statements and the accounting principles
and standards used in their preparation as it deems necessary or
appropriate in the public interest or for the protection of
investors.\266\ In addition, section 17(a) of the Exchange Act more
generally requires registered broker-dealers to make and disseminate
such reports as the Commission, by rule, may prescribe as necessary or
appropriate in the public interest, for the protection of
investors.\267\ The Commission adopted Rule 17a-5, in part, under these
provisions.\268\
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\265\ See 15 U.S.C. 78q(e)(1)(A).
\266\ See 15 U.S.C. 78q(e)(2).
\267\ See 15 U.S.C. 78q(a).
\268\ See Broker-Dealer Reports, Exchange Act Release No. 11935
(Dec. 17, 1975), 40 FR 59706 (Dec. 30, 1975).
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Prior to the enactment of the Sarbanes-Oxley Act of 2002
(``Sarbanes-Oxley Act''),\269\ section 17(e)(1)(A) required that the
annual financial statements a broker-dealer must file with the
Commission be certified by ``an independent public accountant.'' The
Sarbanes-Oxley Act established the PCAOB \270\ and amended section
17(e)(1)(A) by replacing the words ``certified by an independent public
accountant'' with the words ``certified by a registered public
accounting firm.'' \271\ Title I of the Sarbanes-Oxley Act prescribed
specific PCAOB registration, standards-setting, inspection,
investigation, disciplinary, foreign application, oversight, and
funding programs in connection with audits of issuers.\272\ However, as
originally enacted, the Sarbanes-Oxley Act did not expressly prescribe
similar programs in connection with audits of broker-dealers that are
not issuers.
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\269\ Public Law 107-204, 116 Stat. 745 (2002).
\270\ Public Law 107-204 Sec. 101.
\271\ See Public Law 107-204 Sec. 205(c)(2). The term
Registered Public Accounting Firm is defined in section 2(a)(12) as
``a public accounting firm registered with the [PCAOB] in accordance
with this Act.'' See Public Law 107-204 Sec. 2(a)(12).
\272\ Section 2(a)(7) of the Sarbanes-Oxley Act defines the term
issuer as ``an issuer as defined in section 3 of the [Exchange Act],
the securities of which are registered under section 12 of [the
Exchange Act], or that files or has filed a registration statement
that has not yet become effective under the Securities Act of
1933[hellip], and that it has not withdrawn'' (U.S.C. citations
omitted). See Public Law 107-204 Sec. 2(a)(7).
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The Dodd-Frank Act, enacted in July 2010, amended the Sarbanes-
Oxley Act to provide the PCAOB with explicit authority to, among other
things, establish (subject to Commission approval) auditing and related
attestation, quality control, ethics, and independence standards for
registered public accounting firms with respect to their preparation of
audit reports to be included in broker-dealer filings with the
Commission, and the authority to conduct and require an inspection
program of registered public accounting firms that audit broker-
dealers.\273\ The Dodd-Frank Act addressed inspection authority by
adding section 104(a)(2)(A) to the Sarbanes-Oxley Act, which provides
that the PCAOB ``may, by rule, conduct and require a program of
inspection* * *of registered public accounting firms that provide one
or more audit reports for a broker or dealer'' and that the PCAOB, in
establishing a program for inspection, ``may allow for differentiation
among classes of brokers or dealers, as appropriate.'' \274\
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\273\ See Public Law 111-203 Sec. 982.
\274\ See Public Law 111-203 Sec. 982(e)(1).
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The Dodd-Frank Act also added section 104(a)(2)(D) to the Sarbanes-
Oxley Act, which provides that a public accounting firm is not required
to register with the PCAOB if the public accounting firm is exempt from
an inspection program established by the PCAOB.\275\ The Dodd-Frank Act
made a conforming amendment to section 17(e)(1)(A) of the Exchange Act
to replace the words ``certified by a registered public accounting
firm'' with the words ``certified by an independent public accounting
firm, or by a registered public accounting firm if the firm is required
to be registered under the Sarbanes-Oxley Act of 2002.'' \276\
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\275\ Id.
\276\ See Public Law 111-203 Sec. 982(e)(2). As discussed
below, today's amendments to the qualifications of the independent
public accountant provisions require, consistent with amended
section 17(e)(1)(A), that the accountant be qualified, independent,
and registered with the PCAOB ``if required by the Sarbanes-Oxley
Act of 2002.'' See paragraph (f)(1) of Rule 17a-5.
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Before today's amendments, paragraph (g)(1) of Rule 17a-5 required
that audits of broker-dealer reports filed with the Commission under
Rule 17a-5 be made in accordance with generally accepted auditing
standards (``GAAS''), which are established by the Auditing Standards
Board of the American Institute of Certified Public Accountants
(``AICPA''). In light of the authority granted to the PCAOB by the
Dodd-Frank Act to establish standards governing audit reports to be
included in broker-dealer filings with the Commission, the Commission
issued transitional interpretive guidance to clarify that references in
Commission rules, staff guidance, and in the federal securities laws to
GAAS or to specific standards under GAAS, as they relate to non-issuer
brokers or dealers, should continue to be understood to mean auditing
standards generally accepted in the U.S., in addition to any applicable
rules of the Commission.\277\ The
[[Page 51929]]
guidance also stated that the Commission intended to revisit the
interpretation in connection with a rulemaking project to update the
audit and related attestation requirements under the federal securities
laws for broker-dealers.\278\ As discussed below, the Commission is now
adopting amendments to Rule 17a-5 to require that audits and
attestations of broker-dealer reports filed under Rule 17a-5 be made in
accordance with standards of the PCAOB--the rule as amended does not
contain references to GAAS.
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\277\ See Commission Guidance Regarding Auditing, Attestation,
and Related Professional Practice Standards Related to Brokers and
Dealers, Exchange Act Release No. 62991 (Sept. 24, 2010), 75 FR
60616, 60617 (Oct. 1, 2010).
\278\ Id.
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Since the Commission proposed these amendments, the PCAOB has taken
a number of actions to implement the explicit authority over broker-
dealer audits provided to it by the Dodd-Frank Act. For example, on
August 18, 2011, the Commission approved two PCAOB rule changes: a
temporary PCAOB rule that established an interim program of inspection
of audits of broker-dealers,\279\ and a PCAOB rule change providing
that funds to cover the PCAOB's annual budget be allocated among
issuers, brokers, and dealers.\280\ In addition, as discussed below,
subsequent to the Commission's proposal to amend Rule 17a-5, the PCAOB
proposed attestation standards to establish requirements for examining
broker-dealer compliance reports and reviewing broker-dealer exemption
reports ``to align its attestation standards more closely with the
auditor's responsibilities under [the proposed amendments to Rule 17a-
5].'' \281\ The PCAOB concurrently proposed an auditing standard for
supplemental information accompanying audited financial statements that
would supersede the current standard.\282\ The auditing standard would
apply to supporting schedules broker-dealers must file under Rule 17a-
5, including schedules regarding the computation of net capital and the
customer reserve requirement and information related to the broker-
dealer's possession or control of customer assets.\283\ The PCAOB also
proposed amendments ``to tailor certain of its rules to the audits and
[independent public accountants] of broker-dealers.'' \284\
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\279\ See Public Company Accounting Oversight Board; Order
Approving Proposed Temporary Rule for an Interim Program of
Inspection Related to Audits of Brokers and Dealers, Exchange Act
Release No. 65163 (Aug. 18, 2011), 76 FR 52996 (Aug. 24, 2011).
\280\ See Public Company Accounting Oversight Board; Order
Approving Proposed Board Funding Rules for Allocation of the Board's
Accounting Support Fee Among Issuers, Brokers, and Dealers, and
Other Amendments to the Board's Funding Rules, Exchange Act Release
No. 65162 (Aug. 18, 2011), 76 FR 52997 (Aug. 24, 2011).
\281\ See PCAOB Proposing Release at 5.
\282\ See PCAOB Proposed Auditing Standard for Supplemental
Information.
\283\ Id. at 3.
\284\ See Proposed Amendments to Conform the Board's Rules and
Forms to the Dodd-Frank Act and Make Certain Updates and
Clarifications, PCAOB Release No. 2012-002, PCAOB Rulemaking Docket
Matter No. 039 (Feb. 28, 2012).
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2. Engagement of Accountant Requirements Prior to Today's Amendments
Rule 17a-5 requires that a broker-dealer prepare and file certain
financial statements and supporting schedules in addition to the
balance sheet and income statement required under section 17(e)(1)(A)
of the Exchange Act.\285\ Before today's amendments, the financial
statements and supporting schedules were generally required to be
audited in accordance with GAAS by an independent public accountant
registered with the PCAOB.\286\
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\285\ See 17 CFR 240.17a-5(d).
\286\ See 17 CFR 240.17a-5(g). An engagement to perform an audit
(or examination) of financial statements is designed to provide
reasonable assurance about whether the financial statements are free
of material misstatement. See, e.g., PCAOB Interim Auditing
Standard, AU Section 110 at ] .02. The term audit is defined in
section 110(1) of the Sarbanes-Oxley Act, as amended by the Dodd-
Frank Act, to mean ``an examination of the financial statements,
reports, documents, procedures, controls, or notices of an issuer,
broker, or dealer by an independent public accountant in accordance
with the rules of the [PCAOB] or the Commission, for the purpose of
expressing an opinion on the financial statements or providing an
audit report.''
---------------------------------------------------------------------------
In addition to filing a report of the independent public accountant
covering the financial statements and supporting schedules, paragraph
(j) of Rule 17a-5 required the broker-dealer to file with the annual
audit a supplemental report prepared by the accountant (``material
inadequacy report'') that either: (1) Indicated that the accountant did
not find any material inadequacies; or (2) described any material
inadequacies in internal control the accountant found during the course
of the audit of the financial statements and supporting schedules and
any corrective action taken or proposed by the broker-dealer.\287\
---------------------------------------------------------------------------
\287\ See 17 CFR 240.17a-5(j). Prior to today's amendments,
paragraph (g)(3) of Rule 17a-5 describes a material inadequacy in a
broker-dealer's accounting system, internal accounting controls,
procedures for safeguarding securities, and practices and procedures
to include any condition which has contributed substantially to or,
if appropriate corrective action is not taken, could reasonably be
expected to: (1) Inhibit a broker-dealer from promptly completing
securities transactions or promptly discharging its responsibilities
to customers, other broker-dealers or creditors; (2) result in
material financial loss; (3) result in material misstatements of the
broker-dealer's financial statements; or (4) result in violations of
the Commission's recordkeeping or financial responsibility rules to
an extent that could reasonably be expected to result in the
conditions described in (1) through (3) above. See 17 CFR 240.17a-
5(g)(3). In addition to the material inadequacy report, a broker-
dealer was required to file during certain periods a supplemental
report covered by an opinion of the independent public accountant on
the status of the broker-dealer's membership in SIPC. See 17 CFR
240.17a-5(e)(4). The Commission is amending this requirement as
discussed above in section II.C.4. of this release. Further, a
broker-dealer that computes net capital under the alternative model-
based standard in Appendix E to Rule 15c3-1 (17 CFR 240.15c3-1e) is
required to file a supplemental report of an independent public
accountant indicating the results of the accountant's review of the
internal risk management control system established and documented
by the broker-dealer in accordance with Rule 15c3-4 (17 CFR
240.15c3-4). See 17 CFR 240.17a-5(k). The Commission is not amending
this requirement today.
---------------------------------------------------------------------------
For purposes of preparing the material inadequacy report, paragraph
(g)(1) of Rule 17a-5 required that the audit include a ``review'' of
the broker-dealer's accounting system, internal accounting control, and
procedures for safeguarding securities.\288\ Further, the accountant
was required to review the practices and procedures of the broker-
dealer in: (1) Making the periodic computations of aggregate
indebtedness and net capital under paragraph (a)(11) of Exchange Act
Rule 17a-3 and the reserve required by paragraph (e) of Rule 15c3-3;
\289\ (2) making the quarterly securities examinations, counts,
verifications, and comparisons and the recordation of differences
required by Rule 17a-13; \290\ (3) complying with the requirement for
prompt payment for securities under Regulation T of the Board of
Governors of the Federal Reserve System (``Regulation T''); \291\ and
(4) obtaining and maintaining physical possession or control of all
fully paid and excess margin securities of customers as required by
Rule 15c3-3.\292\ The scope of the independent public accountant's
procedures was required to be sufficient to provide ``reasonable
assurance'' that any material inadequacies existing at the date of the
examination in the broker-dealer's accounting system, internal
accounting control, and procedures for safeguarding securities as well
as in the practices and procedures described in items (1) through (4)
above would be disclosed.\293\
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\288\ See 17 CFR 240.17a-5(g)(1).
\289\ See 17 CFR 240.17a-5(g)(1)(i).
\290\ See 17 CFR 240.17a-5(g)(1)(ii).
\291\ See 17 CFR 240.17a-5(g)(1)(iii). See also 12 CFR 220 et
seq. (Regulation T).
\292\ See 17 CFR 240.17a-5(g)(1)(iv).
\293\ See 17 CFR 240.17a-5(g)(1).
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The AICPA Broker-Dealer Audit Guide provided that the material
inadequacy report should address what the independent public accountant
concluded in its ``study'' of the adequacy of the broker-dealer's
[[Page 51930]]
practices and procedures in complying with the financial responsibility
rules in relation to the definition of material inadequacy as stated in
paragraph (g)(3) of Rule 17a-5.\294\ The issuance of a study is
relatively unique to broker-dealer audits, however, and while auditing
standards at one time referred to the performance of a study, current
auditing standards no longer contain such references.
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\294\ The material inadequacy report is addressed in the AICPA's
Audit & Accounting Guide: Brokers and Dealers in Securities (Sept.
1, 2011 ed.) (``AICPA Broker-Dealer Audit Guide''), which provides
that the report should: (1) Address what auditors concluded in their
study of the adequacy of the broker-dealer's practices and
procedures in complying with the Commission's financial
responsibility rules in relation to the definition of a material
inadequacy in Rule 17a-5; and (2) disclose material weaknesses in
internal control over financial reporting (including procedures for
safeguarding securities) that are revealed through auditing
procedures designed and conducted for the purpose of expressing an
opinion on the financial statements. See AICPA Broker-Dealer Audit
Guide at ] 3.77. The AICPA Broker-Dealer Audit Guide further
provides that if conditions believed to be material weaknesses are
found to exist or have existed during the year, the report should
disclose the nature of the weaknesses and the corrective action
taken or proposed to be taken by the broker-dealer. See AICPA
Broker-Dealer Audit Guide at ] 3.80. The AICPA Broker-Dealer Audit
Guide also provides sample reports ``on internal control required by
SEC Rule 17a-5(g)(1).'' See AICPA Broker-Dealer Audit Guide apps. C,
D, and F.
---------------------------------------------------------------------------
Additional engagement of accountant requirements prior to today's
amendments were set forth in paragraphs (g) and (i) of Rule 17a-5.
Paragraph (g)(2) of Rule 17a-5 provided that, if the broker-dealer was
exempt from Rule 15c3-3, the independent public accountant must
ascertain that the conditions of the exemption were being complied with
as of the examination date and that no facts came to the independent
public accountant's attention to indicate that the exemption had not
been complied with during the period since the last examination.\295\
---------------------------------------------------------------------------
\295\ See 17 CFR 240.17a-5(g)(2).
---------------------------------------------------------------------------
Paragraph (i) of Rule 17a-5, before today's amendments, was titled,
``Accountant's reports--general provisions.'' \296\ Paragraph (i)(1) of
Rule 17a-5 provided that the accountant's report must be dated, signed
manually, indicate the city and state where issued, and identify the
financial statements and schedules covered by the report.\297\
Paragraph (i)(2) of Rule 17a-5 provided that the accountant's report
must state whether the audit was made in accordance with generally
accepted auditing standards; state whether the accountant reviewed the
procedures followed for safeguarding securities; and designate any
auditing procedures deemed necessary by the accountant under the
circumstances of the particular case which have been omitted, and the
reason for their omission.\298\ Further, the rule provided that
``[n]othing in this section shall be construed to imply authority for
the omission of any procedure which independent accountants would
ordinarily employ in the course of an audit made for the purpose of
expressing the opinions required under [Rule 17a-5].'' \299\
---------------------------------------------------------------------------
\296\ See 17 CFR 240.17a-5(i).
\297\ See 17 CFR 240.17a-5(i)(1).
\298\ See 17 CFR 240.17a-5(i)(2).
\299\ Id.
---------------------------------------------------------------------------
Prior to today's amendments, paragraph (i)(3) of Rule 17a-5
provided that the accountant's report must state clearly the opinion of
the accountant: (i) with respect to the financial statements and
schedules covered by the report and the accounting principles and
practices; and (ii) as to the consistency of the application of the
accounting principles, or as to any changes in such principles that
have a material effect on the financial statements.\300\ Paragraph
(i)(4) provided that any matters to which the accountant took exception
must be clearly identified, the exception specifically and clearly
stated, and, to the extent practicable, the effect of each such
exception on the related financial statements given.\301\ Paragraph
(i)(5) of Rule 17a-5 provided that the terms audit (or examination),
accountant's report, and certified have the meanings given in Rule 1-02
of Regulation S-X (17 CFR 210.1-02).\302\
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\300\ See 17 CFR 240.17a-5(i)(3).
\301\ See 17 CFR 240.17a-5(i)(4).
\302\ See 17 CFR 240.17a-5(i)(5).
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3. Amended Engagement of Accountant Requirements
i. Proposed Amendments
The Commission proposed to substantially amend paragraph (g) and
remove paragraph (j) of Rule 17a-5, in part, to update the engagement
of the accountant requirements to address outdated or inconsistent
terminology in the rule.\303\ The proposed amendments to paragraph (g)
and removal of paragraph (j) of Rule 17a-5 would have eliminated the
requirement for the accountant to prepare and the broker-dealer to file
a material inadequacy report.\304\ In its place, the independent public
accountant would have been required to prepare, and the broker-dealer
would have been required to file, in addition to a report covering the
financial report, a report covering either the broker-dealer's
compliance report or exemption report, as applicable.\305\
Specifically, the Commission proposed to amend paragraph (g) of Rule
17a-5 to be titled ``Engagement of independent public accountant'' and
to require a broker-dealer required to file annual reports under
paragraph (d) of Rule 17a-5 to engage an independent public accountant,
unless the broker-dealer is subject to the exclusions in paragraphs
(d)(1) and (e)(1)(i) of Rule 17a-5. The independent public accountant,
as part of the engagement, would have been required to undertake to:
(1) Prepare a report based on an examination of the broker-dealer's
financial report in accordance with standards of the PCAOB; and (2)
prepare a report based on an ``examination'' of the assertions of the
broker-dealer in the compliance report in accordance with standards of
the PCAOB \306\ or to prepare a report based on a ``review'' of the
broker-dealer's exemption report in accordance with standards of the
PCAOB.\307\ This provision would have retained the requirement that the
financial statements and supporting schedules be audited by the
independent public accountant, so that the accountant would have
continued to be required to obtain ``reasonable assurance'' about
whether they were free of material misstatement, but would have changed
[[Page 51931]]
the audit standards from GAAS to standards of the PCAOB.\308\
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\303\ See Broker-Dealer Reports, 76 FR at 37578-37579. In
addition, the Commission proposed changing the title of paragraph
(g) from Audit objectives to Engagement of the independent public
accountant. Id. at 37606.
\304\ Id. at 37578-37579.
\305\ Id.
\306\ An attest engagement designed to provide a high level of
assurance is referred to as an ``examination.'' See, e.g., PCAOB
Interim Attestation Standard, AT Section 101 at ] .54. For this type
of engagement, the accountant's conclusion will be expressed in the
form of an opinion. For example, the accountant's conclusion based
on an examination of an assertion could state that in the
accountant's opinion, [the assertion] is fairly stated in all
material respects. See, e.g., PCAOB Interim Attestation Standard, AT
Section 101 at ] .84. The proposed rule provided that the
examination and related report would apply to the broker-dealer's
``assertions'' in the compliance report (and therefore would not
apply to other items in the proposed compliance report; namely, a
statement as to whether the broker-dealer has established a system
of internal control and a description of instances of material non-
compliance, and material weaknesses over compliance with, the
financial responsibility rules).
\307\ An attest engagement designed to provide a moderate level
of assurance is referred to as a ``review.'' See, e.g., PCAOB
Interim Attestation Standard, AT Section 101 at ]] .55, .89. For
this type of engagement, the accountant's conclusion will be
expressed, not in the form of an opinion, but in the form of
``negative assurance.'' See, e.g., PCAOB Interim Attestation
Standard, AT Section 101 at ] .68. For example, the accountant's
conclusion based on a review of an assertion could state that no
information came to the accountant's attention that indicates that
the assertion is not fairly stated in all material respects. See,
e.g., PCAOB Interim Attestation Standard, AT Section 101 at ] .88.
\308\ See Broker-Dealer Reports, 76 FR at 37606. As stated
above, an engagement to perform an audit of financial statements is
designed to provide ``reasonable assurance'' about whether the
financial statements are free of material misstatement. See, e.g.,
PCAOB Interim Attestation Standard, AT Section 101 at ] .54.
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The Commission proposed making conforming amendments to paragraph
(i) of Rule 17a-5, substituting the words ``examinations'' and
``reviews'' for the word ``audits,'' substituting the words ``standards
of the PCAOB'' for ``generally accepted auditing standards,''
substituting ``annual reports'' for ``financial statements,'' and
changing the title to ``Reports prepared by the independent public
accountant.'' The Commission also proposed deleting paragraph (i)(5) of
Rule 17a-5, which provided that the terms ``audit,'' ``examination,''
``accountant's report,'' and ``certified'' have the meanings given in
Rule 1-02 of Regulation S-X. As proposed, paragraph (i)(1) of Rule 17a-
5 would have provided that the independent public accountant's reports
must: be dated; be signed manually; indicate the city and state where
issued; and identify without detailed enumeration the items covered by
the reports. Paragraph (i)(2) of Rule 17a-5 would have provided that
the accountant's report must state whether the examination or review
was made in accordance with standards of the PCAOB and must designate
any examination, and, if applicable, review procedures deemed necessary
by the independent public accountant under the circumstances of the
particular case that have been omitted, and the reason for their
omission. Further, the rule would have provided that ``[n]othing in
this section shall be construed to imply authority for the omission of
any procedure that independent public accountants would ordinarily
employ in the course of an examination or review made for the purpose
of expressing the opinions or statement required under [Rule 17a-5].''
Paragraph (i)(3) of Rule 17a-5 would have provided that the independent
public accountant's reports must state clearly the opinion of the
independent public accountant: (i) with respect to the financial report
and the accounting principles and practices reflected therein and the
compliance report; and (ii) with respect to the financial report, as to
the consistency of the application of the accounting principles, or as
to any changes in such principles that have a material effect on the
financial statements. Paragraph (i)(4) of Rule 17a-5 would have
provided that any matters to which the independent public accountant
takes exception must be clearly identified, the exception thereto
specifically and clearly stated, and, to the extent practicable, the
effect of each such exception on any related items contained in the
annual reports.
As stated above, after the Commission proposed the amendments to
Rule 17a-5, the PCAOB issued proposed standards that ``would establish
requirements for examining the assertions in a broker's or dealer's
compliance report and reviewing a broker's or dealer's assertion in the
exemption report.'' \309\ The PCAOB stated that the proposed standards
were ``tailored to the requirements'' in Rule 17a-5 as proposed to be
amended by the Commission.\310\
---------------------------------------------------------------------------
\309\ See PCAOB Proposing Release at 5.
\310\ Id.
---------------------------------------------------------------------------
ii. Comments
The Commission received several comments regarding the proposed
revisions to the independent accountant engagement requirements in Rule
17a-5.\311\ One commenter stated that GAAS should be used for audits of
non-carrying broker-dealers; or, in the alternative, that the
Commission should delay the effective date for the requirement that the
audit be conducted in accordance with PCAOB standards for smaller
broker-dealers until one year after the approval of the
amendments.\312\ A second commenter stated that PCAOB standards should
apply only for broker-dealers ``permanently subject to PCAOB
inspection'' and that the Commission should not require that audits of
broker-dealers be performed in accordance with PCAOB standards for non-
issuer broker-dealers until the PCAOB determines which non-issuer
broker-dealers will be subject to its permanent inspection
program.\313\
---------------------------------------------------------------------------
\311\ See, e.g., ABA Letter; AICPA Letter; Citrin Letter; E&Y
Letter; Van Kampen/Invesco Letter.
\312\ See Citrin Letter. The Commission also received many
comments seeking additional time to transition to the final rules.
Those comments are discussed below in section V. of this release.
\313\ See AICPA Letter.
---------------------------------------------------------------------------
One commenter noted that the proposing release states that broker-
dealers will be required to file a report by the accountant that
``addresses'' the assertions in the compliance report,\314\ and stated
that the Commission should provide more guidance on what an accountant
must address, as ``nowhere in the Release or in the proposed rules is
there guidance as to what `addresses' means or entails.'' \315\ This
commenter further stated that the Commission ``presumably'' will rely
on PCAOB rules, and suggested that final rules regarding the
accountant's obligations with respect to its examination of the
compliance report should be deferred until after a comment period of at
least 60 days after the PCAOB rules are finalized or the Commission
amends its proposal to include specifics as to what ``address'' means
and what type of review is required by the accountant.\316\ The
commenter also stated that the requirement should not be effective
unless the AICPA Broker-Dealer Audit Guide is revised and updated.\317\
One commenter asked what was expected of the auditor with respect to
the books and records assertion and stated that a separate opinion on
this assertion may entail more detailed procedures as to the source of
the information.\318\
---------------------------------------------------------------------------
\314\ See Broker-Dealer Reports, 76 FR at 37575.
\315\ See ABA Letter.
\316\ Id.
\317\ Id. As stated below, AICPA guidance will no longer be
applicable once standards of the PCAOB apply to broker-dealer annual
reports.
\318\ See Grant Thornton Letter.
---------------------------------------------------------------------------
Another commenter stated that a review engagement should not be
employed for the exemption report because inquiry and observation would
not provide sufficient evidence regarding a broker-dealer's assertion
that it is exempt from the requirements of Rule 15c3-3 and stated that,
under the PCAOB's interim attestation standards, an auditor should not
accept an engagement to perform a ``review'' level of service related
to an entity's compliance with specified requirements or an assertion
with regard to that compliance.\319\ As an alternative, this commenter
suggested an ``agreed-upon procedures'' approach addressing the results
of procedures specified by the Commission or the performance of an
examination engagement if suitable criteria were developed.\320\
Another commenter stated that the benefit of receiving an audit report
covering the exemption report would not justify the cost.\321\
Similarly, a commenter stated that the exemption report should be
replaced with a box to check on the FOCUS Report as the auditor
attestation provided no added benefit.\322\
---------------------------------------------------------------------------
\319\ See E&Y Letter.
\320\ Id.
\321\ See Citrin Letter.
\322\ See Angel Letter.
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Several commenters urged the Commission to clarify the interaction
between material weaknesses in internal control over financial
reporting and material weaknesses in internal control over compliance
with the financial responsibility rules.\323\ One commenter stated that
due to the reliance placed on the financial books and records to
[[Page 51932]]
calculate net capital, it will not be feasible to attest to the
effectiveness of internal control over the financial responsibility
rules without also attesting to internal control over financial
reporting.\324\ The commenter stated that, accordingly, it is necessary
to include internal control over financial reporting within the scope
of the rule. The commenter stated its understanding that accountants
expect to include internal control over financial reporting in their
attestation scope over the financial responsibility rules, and that the
process will include documenting all existing processes and engaging
internal audit to validate the effectiveness of the procedures
implemented through procedural walkthroughs and control testing to
validate management's assertions.\325\ This commenter also stated its
belief that independent public accountants will need ``to include an
attestation of the additional in scope processes within the scope of
their audit work in order to comply with PCAOB requirements.'' \326\
---------------------------------------------------------------------------
\323\ See Deloitte Letter; KPMG Letter; PWC Letter.
\324\ See Van Kampen/Invesco Letter.
\325\ Id.
\326\ Id.
---------------------------------------------------------------------------
As noted above in section II.B.4.ii. of this release, with respect
to the independent public accountant's review of the exemption reports,
one commenter stated that, for example, a bank or clerical error that
results in a broker-dealer that operates under an exemption to Rule
15c3-3 finding itself in possession of customer assets overnight once
during the fiscal year should not ``warrant the `material modification'
of a broker-dealer's Exemption Report.'' \327\ Another commenter noted
that ``to consider a single instance of a broker-dealer failing to
promptly forward a customer's securities as an instance that would
necessitate a material modification creates an unworkable standard.''
\328\
---------------------------------------------------------------------------
\327\ See SIFMA letter.
\328\ See CAI Letter.
---------------------------------------------------------------------------
iii. The Final Rule
The Commission is adopting amendments to the engagement of the
accountant requirements in Rule 17a-5 substantially as proposed, except
for revisions, as discussed in detail below, to clarify the rule's
requirements and to make technical changes. Paragraph (g) of Rule 17a-5
as adopted provides that the independent public accountant engaged by
the broker-dealer to provide reports on the financial report and either
the compliance report or exemption report must, as part of the
engagement undertake to: (1) Prepare a report based on an examination
of the broker-dealer's financial report in accordance with standards of
the PCAOB; and (2) prepare a report based on an examination of certain
enumerated statements of the broker-dealer in the compliance report
\329\ in accordance with standards of the PCAOB or prepare a report
based on a review of the statements in the broker-dealer's exemption
report in accordance with standards of the PCAOB. Additionally, as
proposed, the amendments delete paragraph (j) of Rule 17a-5, which, as
explained above, required that the broker-dealer file with the annual
audit report a material inadequacy report, as well as provisions in
paragraph (g) of Rule 17a-5 requiring that the audit be conducted in
accordance with GAAS and addressing the accountant's review for
material inadequacies.
---------------------------------------------------------------------------
\329\ As discussed above in section II.B.3. of this release, the
final rule does not use the term assertion--the assertions contained
in the proposal are now referred to as statements. These changes are
not intended to be substantive. Paragraph (g) of Rule 17a-5
specifies that the accountant prepare a report based on an
examination of certain statements enumerated in the rule. Similar to
the proposal, the statements subject to the examination do not
include a statement as to whether the broker-dealer has established
a system of internal control or a description of instances of non-
compliance with certain financial responsibility rules.
---------------------------------------------------------------------------
Various commenters suggested that GAAS instead of PCAOB standards
should apply for engagements of accountants with respect to certain
broker-dealer reports, such as reports of non-carrying broker-
dealers.\330\ The Commission believes that requiring GAAS for audits of
broker-dealers that are exempt from Rule 15c3-3 would not be consistent
with the provisions of the Dodd-Frank Act that provide the PCAOB with
explicit authority to establish standards with regard to audits of
broker-dealer reports filed with the Commission.\331\ These provisions
enable the PCAOB to exercise its standard-setting authority over audits
of broker-dealers registered with the Commission. The change from GAAS
to PCAOB auditing standards will facilitate the Commission's regulatory
oversight authority because the Commission has direct oversight
authority over the PCAOB, including the ability to approve or
disapprove the PCAOB's rules and standards. The Commission also has
greater confidence in the quality of audits conducted by an independent
public accountant registered with, and subject to regular inspection
by, the PCAOB.\332\ Further, as the PCAOB develops and implements an
inspection program of broker-dealer audits as contemplated by the Dodd-
Frank Act, that program will include inspection of, among other things,
``registered public accounting firms' current compliance with laws,
rules, and standards in performing audits of brokers and dealers.''
\333\ The requirement that all broker-dealer independent public
accountants comply with the standards established by the PCAOB should
facilitate the development and implementation of its permanent
inspection program, as contemplated by the Dodd-Frank Act.
---------------------------------------------------------------------------
\330\ See AICPA Letter; Citrin Letter.
\331\ See Public Law 111-203 Sec. 982. For example, section
982(a) of the Dodd-Frank Act added section 110 to the Sarbanes-Oxley
Act, which contains definitions of terms such as audit, audit
report, and professional standards. These definitions apply to
audits, audit reports, and professional standards with respect to
audits of broker-dealers as well as audits of issuers. In addition,
section 982(b) of the Dodd-Frank Act amended section 101 of the
Sarbanes-Oxley Act to substitute the words ``issuers, brokers, and
dealers'' for the word ``issuers.''
\332\ See Custody of Funds or Securities of Clients by
Investment Advisers, 75 FR at 1460.
\333\ See Temporary Rule for an Interim Program of Inspection
Related to Audits of Brokers and Dealers, PCAOB Release No. 2011-
001, PCAOB Rulemaking Docket Matter No. 32, 1 (June 14, 2011).
---------------------------------------------------------------------------
As noted above, the PCAOB has proposed an auditing standard for
supplemental information accompanying audited financial statements,
including the supporting schedules broker-dealers must file as part of
the financial report.\334\ The PCAOB stated that a primary factor that
led it to reexamine its requirements regarding supplemental information
was the Commission's proposal to amend the reporting requirements of
Rule 17a-5.\335\ In addition, as noted above, the PCAOB has proposed
specific attestation standards for examining compliance reports and
reviewing exemption reports. The PCAOB's proposing release noted that
the proposed standards ``are tailored to the requirements in SEC
Proposed Rule 17a-5.'' \336\ The proposed standards, if adopted, would
establish a single and broker-dealer-specific approach to examining
compliance reports and reviewing exemption reports. This should provide
greater clarity as to procedures an independent public accountant
should use in examining a compliance report and reviewing an exemption
report.
---------------------------------------------------------------------------
\334\ See PCAOB Proposed Auditing Standard for Supplemental
Information.
\335\ Id. at 2-3.
\336\ See PCAOB Proposing Release at 5.
---------------------------------------------------------------------------
With respect to comments suggesting that PCAOB standards should
apply only to auditors of broker-dealers ``permanently subject to PCAOB
inspection,'' \337\ the PCAOB has not exempted the audits by
independent
[[Page 51933]]
public accountants of any class of broker-dealer from the PCAOB's
permanent inspection program.\338\ In fact, the PCAOB has established
an interim inspection program for all broker-dealer audits by
independent public accountants that will ``allow the Board to begin
inspections of relevant audits and auditors and provide a source of
information to help guide decisions about the scope and elements of a
permanent program.'' \339\ The PCAOB stated that it did not intend ``to
postpone all use of its new inspection authority until after those
judgments were made.'' \340\
---------------------------------------------------------------------------
\337\ See AICPA Letter.
\338\ See Public Company Accounting Oversight Board: Order
Approving Proposed Temporary Rule for an Interim Program of
Inspection Related to Audits of Brokers and Dealers, Exchange Act
Release No. 65163 (Aug. 18, 2011), 76 FR at 52996 (Aug. 24, 2011).
\339\ Id. at 52997.
\340\ Id.
---------------------------------------------------------------------------
At this time, there is no reason to expect that any type of broker-
dealer audit will be exempt from the PCAOB's permanent inspection
program, and any PCAOB determination to exempt broker-dealer audits
from the PCAOB's permanent inspection program must be approved by the
Commission. Therefore, notwithstanding any such exemption, paragraph
(g) of Rule 17a-5 is amended to require that broker-dealer independent
public accountants prepare reports covering the financial report and
compliance report or exemption report in accordance with standards of
the PCAOB.
On August 20, 2012, the PCAOB published its first report on the
progress of the interim inspection program.\341\ The report contains
observations from inspections of portions of 23 broker-dealer audits
conducted by ten independent public accounting firms that were all
conducted in accordance with GAAS.\342\ The inspections did not exclude
any broker-dealer audits from being eligible for selection.\343\ PCAOB
staff identified deficiencies in all of the audits inspected.\344\ For
example, as to all of the 14 audits of broker-dealers that claimed an
exemption from Rule 15c3-3, the staff stated that the accountant ``did
not perform sufficient procedures to ascertain that the broker or
dealer complied with the conditions of the exemption,'' \345\ and in 21
of the 23 audits, that the accountant ``failed to perform sufficient
audit procedures to obtain reasonable assurance that any material
inadequacies found to exist since the date of the last examination . .
. would have been disclosed in the accountant's supplemental report.''
\346\ The deficiencies noted in the PCAOB's report on the progress of
the interim inspection program provide further support for the
amendments that the Commission is adopting today to establish the
foundation for the PCAOB's development of standards that are tailored
to Rule 17a-5, and to strengthen and facilitate consistent compliance
with broker-dealer audit and reporting requirements.
---------------------------------------------------------------------------
\341\ See PCAOB, Report on the Progress of the Interim
Inspection Program Related to Audits of Brokers and Dealers, PCAOB
Release No. 2012-005 (August 20, 2012) (``PCAOB Inspection
Report'').
\342\ Id. at ii.
\343\ Id. at 8.
\344\ Id. at ii.
\345\ Id. at iii.
\346\ Id.
---------------------------------------------------------------------------
Several commenters suggested that the Commission delay the
applicability of these requirements because, among other things, PCAOB
standards regarding broker-dealer audits, including standards that
apply to compliance reports and exemption reports, will not be final
when these rule amendments are adopted.\347\ In response, as discussed
below in section V. of this release, the Commission is delaying the
effective dates of most of the rule amendments. In accordance with the
effective dates, broker-dealers must file compliance reports or
exemption reports, as applicable, and broker-dealers must file reports
of independent public accountants covering compliance reports or
exemption reports in accordance with Rule 17a-5 as amended, for fiscal
years ending on or after June 1, 2014. In the interim, broker-dealers
must continue to file material inadequacy reports in accordance with
the provisions of Rule 17a-5 as they existed before today's amendments.
Broker-dealer independent public accountants must prepare reports based
on an examination of broker-dealer financial reports in accordance with
PCAOB standards for fiscal years ending on or after June 1, 2014. In
the interim, audits of broker-dealer financial statements filed with
the Commission under Rule 17a-5 should continue to be understood to
mean auditing standards generally accepted in the U.S., plus any
applicable rules of the Commission.\348\ The June 1, 2014 effective
date should provide sufficient time for the PCAOB to finalize, subject
to Commission approval, the standards for broker-dealer audits and for
broker-dealers and their independent public accountants to prepare to
comply with the new requirements and standards.
---------------------------------------------------------------------------
\347\ See, e.g., CAQ Letter; Deloitte Letter; Grant Thornton
Letter; KPMG Letter; McGladrey Letter.
\348\ See Commission Guidance Regarding Auditing, Attestation,
and Related Professional Practice Standards Related to Brokers and
Dealers, Exchange Act Release No. 62991 (Sept. 24, 2010), 75 FR
60616, 60617 (Oct. 1, 2010).
---------------------------------------------------------------------------
As noted above, one commenter stated the Commission should provide
more guidance on what an independent public accountant must address,
and that the requirement for PCAOB standards should not be effective
unless the AICPA Broker-Dealer Audit Guide is revised and updated.\349\
Another commenter sought clarification on what was expected of the
auditor with respect to the books and records assertion.\350\ In
response to these comments, the Commission notes that the PCAOB's
proposed standards with respect to the examination of the compliance
report by the independent public accountant address, among other
things: (1) The objective of the examination; (2) the relationship
between the examination engagement and the audit of the financial
report; (3) considerations for broker-dealers with multiple divisions
or branches; (4) identifying risks of material non-compliance; (5)
testing controls over compliance; (6) performing compliance tests; (7)
testing information used to assert compliance; (8) evaluating the
results of the examination procedures; (9) subsequent events; (10)
obtaining a representation letter; (11) communication requirements;
(12) reporting on the examination engagement; (13) the examination
report date; and (14) examination report modifications.\351\ The
PCAOB's proposed standards with respect to the review of the exemption
report by the independent public accountant address, among other
things: (1) The objective of the review; (2) the relationship between
the review engagement and the audit of the financial report; (3) the
review procedures; (4) evaluating the results of the examination
procedures; (5) obtaining a representation letter; (6) communication
requirements; (7) reporting on the review engagement; (8) the review
report date; and (9) review report modifications.\352\ The Commission
expects that the final standards of the PCAOB, which are subject to
Commission approval, will provide sufficient guidance to independent
public accountants performing examinations of compliance reports and
reviews of exemption reports.
---------------------------------------------------------------------------
\349\ See ABA Letter.
\350\ See Grant Thorton Letter.
\351\ See PCAOB Proposing Release app. 1.
\352\ See PCAOB Proposing Release app. 2.
---------------------------------------------------------------------------
In response to the comment that the requirements with respect to
the compliance reports and exemption reports should not be effective
unless
[[Page 51934]]
the AICPA Broker-Dealer Audit Guide is revised and updated, as stated
above, once adopted, only the standards of the PCAOB apply to broker-
dealer annual reports. The PCAOB has proposed standards with respect to
the examination of the compliance report and the review of the
exemption report and it is expected that final standards will be in
place before the audit requirements with respect to the compliance
report and the exemption report are effective. Consequently, there is
no need to wait for the AICPA Broker-Dealer Audit Guide to be updated.
As noted above, several commenters requested clarity about the
interaction between material weaknesses in internal control over
financial reporting and material weaknesses in internal control over
compliance with the financial responsibility rules.\353\ Additionally,
one commenter stated that due to the reliance placed on the financial
books and records of the broker-dealer, it will not be feasible for the
independent public accountant to attest to the effectiveness of
internal control over the financial responsibility rules without also
attesting to internal control over financial reporting.\354\ As
discussed above in section II.B.3.iii. of this release, although a
broker-dealer is required to state in the compliance report that the
information it used to state whether it was in compliance with Rule
15c3-1 and paragraph (e) of Rule 15c3-3 was derived from its books and
records, the final rule does not require that the broker-dealer include
a statement regarding the effectiveness of its internal control over
the accuracy of its books and records, nor does it require that the
independent public accountant attest to the effectiveness of internal
control over the accuracy of the broker-dealer's books and records.
Additionally, under the final rule, the independent public accountant
is not required to opine on the effectiveness of the broker-dealer's
internal control over financial reporting. However, the independent
public accountant's existing obligation to gain an understanding and
perform appropriate procedures relative to the broker-dealer's internal
control over financial reporting, as a necessary part of the
independent public accountant's financial report audit, remains
unchanged.\355\ Further, as discussed above in section II.B.3.iii. of
this release, the examination of the compliance report would pertain
solely to certain statements in the compliance report and not to the
broker-dealer's process for arriving at the statements. The report of
the independent public accountant, based on the examination of the
compliance report, requires the accountant to perform its own
independent examination of the related controls and procedures.
Consequently, it is not necessary for the independent public accountant
to provide an opinion with regard to the process that the broker-dealer
used to arrive at its conclusions.
---------------------------------------------------------------------------
\353\ See Deloitte Letter; KPMG Letter; PWC Letter.
\354\ See Van Kampen/Invesco Letter.
\355\ See PCAOB Auditing Standard, AS No. 12 (for audits of
fiscal years beginning on or after December 15, 2010).
---------------------------------------------------------------------------
As noted above, one commenter stated that a review engagement
should not be employed for the exemption report, because an
accountant's inquiry and observation would not provide sufficient
evidence regarding a broker-dealer's assertion that it is exempt from
Rule 15c3-3, and under the PCAOB's attestation standards, an auditor
should not accept an engagement to perform a ``review'' engagement
related to an entity's compliance with specified requirements.\356\ As
an alternative, this commenter suggested an ``agreed-upon procedures''
approach or an examination engagement.\357\
---------------------------------------------------------------------------
\356\ See E&Y Letter.
\357\ Id.
---------------------------------------------------------------------------
The PCAOB's attestation standards currently provide that an
accountant should not accept an engagement to perform a review of an
entity's compliance with specified requirements or about the
effectiveness of an entity's internal control over compliance, and that
an agreed upon procedures engagement be considered as an
alternative.\358\ Irrespective of the PCAOB's current standards, Rule
17a-5, as amended, provides that the broker-dealer engage an
independent public accountant to perform a review of the exemption
report. Moreover, in July 2011, as part of its proposed standards for
attestation engagements related to broker-dealer compliance reports or
exemption reports, the PCAOB proposed replacing the provision cited by
the commenter with the following: ``When a practitioner is engaged to
perform a review engagement on assertions made by a broker or dealer in
an exemption report that is prepared pursuant to SEC Proposed Rule 17a-
5, the practitioner must conduct the review engagement pursuant to
Proposed Attestation Standard, Review Engagements Regarding Exemption
Reports of Brokers and Dealers.'' \359\ In addition, as discussed
above, the PCAOB has proposed specific standards for an accountant to
perform a review of the exemption report.\360\ The PCAOB's final
standards, which must be approved by the Commission, are intended by
the PCAOB to clarify the procedures an independent public accountant
will need to perform in a review of an exemption report.\361\
---------------------------------------------------------------------------
\358\ See PCAOB Interim Attestation Standard, AT Section 601 at
] 7.
\359\ See PCAOB Proposing Release app. 3 at A3-4. The PCAOB's
attestation standards currently provide that an accountant should
not accept an engagement to perform a review of an entity's
compliance with specified requirements or about the effectiveness of
an entity's internal control over compliance or an assertion
regarding those items. See PCAOB Interim Attestation Standard, AT
Section 601 at ] 7.
\360\ See PCAOB Proposing Release app. 2.
\361\ Id.
---------------------------------------------------------------------------
In response to the comment that a review engagement should not be
employed for the exemption report because inquiry and observation would
not provide sufficient evidence,\362\ the independent public accountant
would be able to obtain the moderate level of assurance contemplated by
the required review through a combination of procedures that the
accountant would perform in connection with the financial audit
currently required under Rule 17a-5 and certain inquiries and other
procedures specifically targeting the exemption report. Also, the
PCAOB's proposal includes specific requirements for a review engagement
regarding exemption reports of brokers and dealers. In addition to
inquiry and observation, the PCAOB's proposal states that ``in
performing the review engagement, the auditor should . . . [e]valuate
whether the evidence obtained and the results of the procedures
performed in the audit of the financial statements and supplemental
information corroborate or contradict the broker's or dealer's
assertion regarding compliance with the exemption conditions.'' \363\
Additionally, the auditor should ``[p]erform other procedures as
necessary in the circumstances to obtain moderate assurance.'' \364\
The PCAOB's final standards will provide clarity on the procedures to
be performed by the independent public accountant to obtain a moderate
level of assurance to form a conclusion with respect to the review of
the exemption report.\365\
---------------------------------------------------------------------------
\362\ See E&Y Letter.
\363\ See PCAOB Proposing Release app. 2.
\364\ Id.
\365\ Id.
---------------------------------------------------------------------------
The commenter's suggestion to use an ``agreed-upon procedures''
engagement for the exemption report was considered. The final rule,
however, requires a review engagement as proposed. Under an ``agreed-
upon procedures'' engagement, the independent public accountant is
[[Page 51935]]
engaged by a client to issue a report of findings based on specific
procedures performed on subject matter that the specified parties
believe are appropriate.\366\ Additionally, in an ``agreed-upon
procedures'' engagement, the independent public accountant does not
perform an examination or a review, and does not provide an opinion or
negative assurance. Thus, no conclusion would be rendered as to the
broker-dealer's statement that it met certain exemption provisions in
Rule 15c3-3.
---------------------------------------------------------------------------
\366\ See PCAOB Interim Attestation Standard, AT Section 201 at
] .03.
---------------------------------------------------------------------------
In addition to the commenter advocating an ``agreed-upon
procedures'' standard,\367\ a second commenter stated that the cost
``would not justify the need'' for an audit report covering the
exemption report \368\ and a third commenter stated that the exemption
report should be replaced with a box to check on the FOCUS Report as
the auditor attestation provided no added benefit.\369\ In response to
all these comments, the Commission notes that previously Rule 17a-5
required that if a broker-dealer is exempt from Rule 15c3-3, the
independent public accountant is required to ascertain whether the
conditions of the exemption were being complied with and that no facts
came to the accountant's attention to indicate that the exemption had
not been complied with.\370\ Consequently, the rule previously required
the independent public accountant to reach a conclusion with respect to
a broker-dealer's claimed exemption from Rule 15c3-3. The Commission
believes that the rule should continue to require a conclusion from the
independent public accountant on the broker-dealer's claimed exemption
from Rule 15c3-3 because of the importance of safeguarding customer
securities and cash. Consequently, the Commission does not believe that
it would be appropriate to use a lower standard (i.e., the agreed-upon
procedures standard) or to have no requirement for the independent
public accountant to perform any work with respect to the exemption
report. Moreover, because the independent public accountant was
previously required to render a conclusion with respect to the broker-
dealer's claimed exemption from Rule 15c3-3, the exemption report
review should not result in significant incremental cost over the
existing requirement.
---------------------------------------------------------------------------
\367\ See E&Y Letter.
\368\ See Citrin Letter.
\369\ See Angel Letter.
\370\ See 17 CFR 240.17a-5(g)(2).
---------------------------------------------------------------------------
As noted above, two commenters raised concerns that minor
exceptions to meeting the exemption provisions of paragraph (k) of Rule
15c3-3 could result in the independent public accountant becoming aware
of material modifications that should be made to the statement in the
exemption report.\371\ Under PCAOB standards for attestation
engagements, the independent public accountant's review report on a
statement in an exemption report would be required to include a
statement about whether the accountant is aware of any material
modifications that should be made to the statement in the exemption
report in order for it to be fairly stated in all material
respects.\372\ As discussed above in section II.B.4.iii. of this
release, the exemption report requirements have been modified from the
proposal so that a broker-dealer must either state that it met the
identified exemption provisions in paragraph (k) throughout the most
recent fiscal year without exception or that it met the identified
exemption provisions throughout the most recent fiscal year except as
described in the report. Consequently, a broker-dealer that had
exceptions will state that fact in the exemption report and describe
the exceptions. Under PCAOB standards, if the statement is fairly
stated in all material respects, including descriptions of any
exceptions, the broker-dealer's independent public accountant would not
need to state that the accountant is aware of any material
modifications that should be made to the statement.\373\
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\371\ See CAI Letter; SIFMA letter.
\372\ See PCAOB Interim Attestation Standard, AT Section 101 at
] .90. See also PCAOB Proposing Release app. 2 at ] 11 (``The
auditor should evaluate the identified instances of non-compliance
with the exemption conditions to determine whether the instances of
non-compliance, individually or in combination, cause the broker's
or dealer's assertion not to be fairly stated, in all material
respects. If the broker's or dealer's assertion is not fairly
stated, in all material respects, the auditor should: (a) Modify the
review report . . . and (b) evaluate the effect of the matter on the
audit of the financial statements and supplemental information.'').
\373\ See PCAOB Interim Attestation Standard, AT Section 101 at
] .67 (stating that in expressing its conclusion, an independent
public accounting ``should consider an omission or a misstatement to
be material if the omission or misstatement--individually or when
aggregated with others--is such that a reasonable person would be
influenced by the omission or misstatement.'').
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The Commission did not receive comments regarding the proposed
amendments to paragraph (i) of Rule 17a-5. However, the final rule has
been revised from the proposal for clarity and consistency with the
other amendments to Rule 17a-5. The title of the rule has been modified
from the proposal to add a citation for clarity. As adopted, the title
is, ``Reports of the independent public accountant required under
paragraph (d)(1)(i)(C) of [Rule 17a-5].'' As adopted, paragraph (i)(1)
of Rule 17a-5 provides, as proposed, that the independent public
accountant's reports must: Be dated; be signed manually; indicate the
city and state where issued; and identify without detailed enumeration
the items covered by the reports.
Paragraph (i)(2) of Rule 17a-5, as adopted, is also consistent with
the proposal except that the word ``Identify'' is substituted for the
word ``Designate'' for clarity and the phrase ``opinions or
conclusions'' is substituted for the phrase ``opinions or statement''
because as explained above, consistent with auditing standards, a
review engagement will not result in an opinion, but in the
accountant's conclusion in the form of ``negative assurance''--for
example, a conclusion that no information came to the accountant's
attention that indicates that a statement is not fairly stated in all
material respects.\374\ The rule therefore provides that the
independent public accountant's reports must: (i) State whether the
examinations or review, as applicable, were made in accordance with
standards of the PCAOB; (ii) identify any examination and, if
applicable, review procedures deemed necessary by the independent
public accountant under the circumstances of the particular case that
have been omitted and the reason for their omission. The rule also
provides that: ``[n]othing in this section may be construed to imply
authority for the omission of any procedure that independent public
accountants would ordinarily employ in the course of an examination or
review made for the purpose of expressing the opinions or conclusions
required under [Rule 17a-5].''
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\374\ Id. at ]] .68, .88.
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Paragraph (i)(3) of Rule 17a-5, as adopted, is re-organized for
clarity. Specific reference has been added to those statements in the
compliance report that the accountant must examine, consistent with
other amendments to Rule 17a-5 (e.g., the amendments to paragraph
(g)(2)(i) of Rule 17a-5 regarding the engagement of the accountant to
prepare a report based on the examination of specified statements in
the compliance report). In addition, a subparagraph is added to include
a reference to the exemption
[[Page 51936]]
report.\375\ The rule provides that the independent public accountant's
reports must state clearly: (i) The opinion of the independent public
accountant with respect to the financial report required under
paragraph (d)(1)(i)(A) of Rule 17a-5 and the accounting principles and
practices reflected in that report; (ii) the opinion of the independent
public accountant with respect to the financial report required under
paragraph (d)(1)(i)(A) of Rule 17a-5, as to the consistency of the
application of the accounting principles, or as to any changes in those
principles, that have a material effect on the financial statements;
and (iii) either (A) the opinion of the independent public accountant
with respect to the statements required under paragraphs
(d)(3)(i)(A)(2), (3), (4), and (5) of Rule 17a-5 in the compliance
report required under paragraph (d)(1)(i)(B)(1) of Rule 17a-5, or (B)
the conclusion of the independent public accountant with respect to the
statements required under paragraphs (d)(4)(i), (ii), and (iii) of Rule
17a-5. The specific references to the compliance report and exemption
report in paragraph (i)(3) are intended to provide a complete
description of what must be contained in the report of the independent
public accountant under current attestation standards, which require a
conclusion in the case of an examination to be expressed in the form of
an opinion and a conclusion in the case of a review that is not
expressed in the form of an opinion, but in the form of ``negative
assurance.'' \376\
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\375\ As proposed, paragraph (i)(3) did not contain a reference
to the exemption report. See Broker-Dealer Reports, 76 FR at 37607.
The final rule makes clear that the auditor's conclusion must be
included in the independent public accountant's report covering the
exemption report.
\376\ As noted above, the accountant's conclusion in an
examination engagement will be expressed in the form of an opinion.
For example, the accountant's conclusion based on an examination of
an assertion could state that in the accountant's opinion, the
assertion is fairly stated in all material respects. See, e.g.,
PCAOB Interim Attestation Standard, AT Section 101 at ] .84. The
accountant's conclusion in a review engagement will be expressed,
not in the form of an opinion, but in the form of ``negative
assurance.'' See, e.g., PCAOB Interim Attestation Standard, AT
Section 101 at ] .68. For example, the accountant's conclusion based
on a review of an assertion could state that no information came to
the accountant's attention that indicates that the assertion is not
fairly stated in all material respects. See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ] .88.
---------------------------------------------------------------------------
Paragraph (i)(4) of Rule 17a-5 has been modified from the proposal
to add a reference to paragraph (d) to make it more clear that the
annual reports referenced in the paragraph are the financial report,
compliance report, and exemption report prescribed in paragraph (d). In
addition--in the interest of using ``plain English'' in the
Commission's rules--the word ``must'' has been substituted for the word
``shall'' and the word ``thereto'' has been eliminated. The rule as
adopted therefore provides that ``[a]ny matters to which the
independent public accountant takes exception must be clearly
identified, the exceptions must be specifically and clearly stated,
and, to the extent practicable, the effect of each such exception on
any related items contained in the annual reports required under
paragraph (d) of [Rule 17a-5] must be given.''
E. PCAOB Registration of Independent Public Accountant--Paragraph
(f)(1) of Rule 17a-5
Prior to today's amendments, paragraph (f)(1) of Rule 17a-5 was
titled ``Qualification of accountants'' and provided that: ``The
Commission will not recognize any person as a certified public
accountant who is not duly registered and in good standing as such
under the laws of his place of residence or principal office.'' \377\
Paragraph (f)(3) of Rule 17a-5 provided that the accountant ``shall be
independent in accordance with the provisions of Sec. 210.2-01 (b) and
(c) of this chapter'' and, paragraph (e)(1)(i) of Rule 17a-5 provided
that the accountant ``shall be in fact independent as defined in
paragraph (f)(3) of this section.'' \378\
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\377\ See 17 CFR 240.17a-5(f)(1).
\378\ See 17 CFR 240.17a-5(f)(3).
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As discussed above, section 17(e)(1)(A) of the Exchange Act, as
amended by the Dodd-Frank Act, requires registered broker-dealers to
annually file financial statements with the Commission certified by
``an independent public accounting firm, or by a registered public
accounting firm if the firm is required to be registered under the
Sarbanes-Oxley Act of 2002.'' Accordingly, the Commission proposed
amending paragraph (f)(1) to provide that: ``The independent public
accountant must be qualified and independent in accordance with Sec.
210.2-01 of this chapter and, in addition, the independent public
accountant must be registered with the Public Company Accounting
Oversight Board if required by the Sarbanes-Oxley Act of 2002.'' \379\
The Commission further proposed deleting the accountant independence
language in paragraph (e)(1)(i) of Rule 17a-5.\380\ In addition, the
Commission proposed deleting paragraph (f)(3) and re-designating
paragraph (f)(4) as paragraph (f)(3).\381\ These proposed amendments to
paragraph (f) of Rule 17a-5 would consolidate the provisions of
paragraphs (e)(1)(i), (f)(1), and (f)(3) of Rule 17a-5 into paragraph
(f)(1) and make Rule 17a-5 consistent with other Commission
requirements governing the qualifications of accountants. The
Commission received no comments on these proposals and is adopting them
substantially as proposed.\382\
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\379\ See Broker-Dealer Reports, 76 FR at 37593-37594.
\380\ Id.
\381\ Id.
\382\ See paragraph (f)(1) of Rule 17a-5. The Commission has
revised paragraph (f)(1) of Rule 17a-5 from the proposal to: Change
the title from ``Qualification of accountants'' to ``Qualifications
of independent public accountant;'' and deleting the words ``in
addition.''
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Although the underlying independence requirements have not changed,
broker-dealers and their independent public accountants are reminded
that they must comply with the independence requirements of Rule 2-01
of Regulation S-X.\383\ As a result of the Sarbanes-Oxley Act of 2002,
Rule 2-01 of Regulation S-X was strengthened, including increased
restrictions on the provision of certain non-audit services to an audit
client.\384\
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\383\ See 17 CFR 210.2-01.
\384\ See Strengthening the Commission's Requirements Regarding
Auditor Independence, Exchange Act Release No. 47265 (Jan. 28,
2003), 68 FR 6006 (Feb. 5, 2003). See also Auditor Independence: SEC
Review of Auditor Independence Rules, NASD Notice to Members 02-19
(Mar. 2002).
---------------------------------------------------------------------------
Under the Commission's rules, an accountant will not be recognized
as independent with respect to an audit client if the accountant is
not, or a reasonable investor with knowledge of all relevant facts and
circumstances would conclude that the accountant is not, capable of
exercising objective and impartial judgment on all issues encompassed
within the accountant's engagement. In determining whether an
accountant is independent, the Commission will consider all relevant
circumstances, including all relationships between the accountant and
the audit client, and not just those relating to reports filed with the
Commission.\385\ The standard is predicated largely on whether a
relationship or the provision of a service: (1) Creates a mutual or
conflicting interest between the accountant and the audit client; (2)
places the accountant in the position of auditing his or her own work;
(3) results in the accountant acting as management or an employee of
the audit client; or (4) places the accountant in a position of being
an advocate for the audit client.\386\
---------------------------------------------------------------------------
\385\ See 17 CFR 210.2-01(b).
\386\ See 17 CFR 210.2-01, Preliminary Note 2.
---------------------------------------------------------------------------
Further, Rule 2-01 of Regulation S-X sets forth a non-exclusive
specification
[[Page 51937]]
of circumstances that are inconsistent with the general standard. For
example, the accountant is prohibited from providing the following non-
audit services, among others, to an audit client: \387\
---------------------------------------------------------------------------
\387\ See 17 CFR 210.2-01(c).
---------------------------------------------------------------------------
Bookkeeping or other services related to the accounting
records or financial statements of the audit client;
Financial information systems design and implementation;
and
Management functions or human resources.
With respect to bookkeeping or other services related to the
accounting records or financial statements of the audit client, Rule 2-
01(c)(4)(i) of Regulation S-X specifies that these services include:
(1) Maintaining or preparing the audit client's accounting records; (2)
preparing financial statements that are filed with the Commission or
the information that forms the basis of financial statements filed with
the Commission; or (3) preparing or originating source data underlying
the audit client's financial statements.\388\
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\388\ See 17 CFR 210.2-01(c)(4)(i).
---------------------------------------------------------------------------
Not all of the independence requirements in Rule 2-01 of Regulation
S-X that are applicable to audits of issuers are applicable to
engagements under Rule 17a-5. Specifically, auditors of broker-dealers
are not subject to the partner rotation requirements or the
compensation requirements of the Commission's independence rules
because the statute mandating those requirements is limited to
issuers.\389\ Additionally, auditors of broker-dealers are not subject
to the audit committee pre-approval requirements \390\ or the cooling-
off period requirements for employment \391\ because those requirements
only reference issuers.
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\389\ See 15 U.S.C. 78j-1.
\390\ See 17 CFR 210.2-01(c)(7).
\391\ See 17 CFR 210.2-01(c)(2).
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F. Notification of Non-Compliance or Material Weakness
As discussed in detail below, the Commission is amending the
notification provisions in Rule 17a-5 and amending Rule 17a-11 to align
that rule with the amendments to Rule 17a-5. Under Rule 17a-11, a
broker-dealer must provide notice to the Commission and its DEA in
certain circumstances.\392\ For example, paragraph (b)(1) of Rule 17a-
11 requires a broker-dealer to give notice if its net capital declines
below the minimum amount required under Rule 15c3-1.\393\ Rule 15c3-1
and Rule 15c3-3 also require broker-dealers to provide notification in
certain circumstances.\394\ For example, paragraph (i) of Rule 15c3-3
requires a carrying broker-dealer to immediately notify the Commission
and its DEA if it fails to make a deposit into its customer reserve
account as required by paragraph (e) of Rule 15c3-3.\395\
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\392\ See 17 CFR 240.17a-11.
\393\ See 17 CFR 240.17a-11(b)(1).
\394\ See, e.g., 17 CFR 240.15c3-1(a)(6)(iv)(B); 17 CFR
240.15c3-1(a)(6)(v); 17 CFR 240.15c3-1(a)(7)(ii); 17 CFR 240.15c3-
1(c)(2)(x)(C)(1); 17 CFR 240.15c3-1(e); 17 CFR 240.15c3-1d(c)(2); 17
CFR 240.15c3-3(i).
\395\ See 17 CFR 240.15c3-3(i).
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1. New Notification Requirements--Paragraph (h) of Rule 17a-5
Prior to today's amendments, paragraph (h)(2) of Rule 17a-5
provided that if, during the course of the audit or interim work, the
independent public accountant determined that any ``material
inadequacies'' existed, then the independent public accountant was
required to inform the chief financial officer (``CFO'') of the broker-
dealer, who, in turn, was required to give notice to the Commission and
the broker-dealer's DEA within 24 hours in accordance with the
provisions of Rule 17a-11.\396\ The rule also provided that the broker-
dealer must furnish the independent public accountant with the notice,
and if the independent public accountant failed to receive the notice
within the 24 hour period, or if the accountant disagreed with any
statements contained in the notice, the independent public accountant
was required to inform the Commission and the DEA within the next 24
hours.\397\ In that event, the independent public accountant was
required to describe any material inadequacies found to exist or, if
the broker or dealer filed a notice, the independent public accountant
was required to detail the aspects of the broker-dealer's notice with
which the independent public accountant did not agree.\398\
---------------------------------------------------------------------------
\396\ See 17 CFR 240.17a-5(h)(2).
\397\ Id.
\398\ Id.
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i. The Proposed Amendments
The proposed amendments to Rule 17a-5 would have replaced
references to material inadequacies, including the material inadequacy
report, with a requirement applicable to carrying broker-dealers to
identify an instance of ``material non-compliance'' with the financial
responsibility rules and any material weakness in internal control over
compliance with the financial responsibility rules in the compliance
report and the requirement to engage an independent public accountant
to examine the compliance report.\399\ Consistent with those proposed
changes, the Commission proposed amending the notification provisions
of paragraph (h)(2) of Rule 17a-5 to replace the term ``material
inadequacy'' with the term ``material non-compliance,'' which would
result in a requirement to notify the Commission upon the discovery by
the accountant during the course of preparing a report based on an
examination of the compliance report of an instance of material non-
compliance as that term was proposed to be defined under the
amendments.\400\
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\399\ See Broker-Dealer Reports, 76 FR at 37575-37579.
\400\ Id. at 37579.
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The Commission also proposed amending provisions regarding the
notification process.\401\ Under the proposal, the accountant would
have been required to notify the Commission and the broker-dealer's DEA
directly.\402\ In the proposing release, the Commission stated that it
preliminarily believed these changes would provide more effective and
timely notice of broker-dealer compliance deficiencies and enable the
Commission to react more quickly to protect customers and others
adversely affected by those deficiencies.\403\ The amendments also
would have been consistent with the notification requirement in Rule
206(4)-2 that is triggered in the context of a ``surprise'' examination
of an investment adviser.\404\
---------------------------------------------------------------------------
\401\ Id.
\402\ Id.
\403\ Id.
\404\ Id. Rule 206(4)-2 provides, in pertinent part, that upon
finding any ``material discrepancies'' during the ``surprise''
examination of an investment adviser to verify client funds and
securities, the independent public accountant must notify the
Commission within one business day. 17 CFR 275.206(4)-2(a)(4)(ii).
---------------------------------------------------------------------------
ii. Comments Received
The Commission received numerous comments in response to this
proposal.\405\ Most of these commenters objected to the proposed
notification process.\406\ Among the reasons given were that it would
be inappropriate to require the accountant to notify the Commission and
the DEA directly, because, among other things, the broker-dealer is
principally responsible for compliance with the securities laws,
[[Page 51938]]
including timely notification; \407\ that PCAOB standards provide that
``the practitioner should not take on the role of the responsible
party;'' \408\ and that PCAOB attestation standards (which were
referenced in the proposing release) clearly provide that management is
responsible for the subject matter to which it is asserting, and not
the accountant.\409\ In addition, one commenter stated that alignment
of notification procedures (that is, to require the accountant to
notify the Commission directly) between Rule 17a-5 and Rule 206(4)-2 is
not necessary, given the other auditing and reporting responsibilities
in place or proposed.\410\ In addition to suggestions that the
notification process that existed prior to today's amendments should
not be changed,\411\ one commenter stated that the rule should require
simultaneous notice by the accountant to the Commission and to the
firm's management.\412\
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\405\ See ABA Letter; CAI Letter; CAQ Letter; Deloitte Letter;
E&Y Letter; Grant Thornton Letter; KPMG Letter; McGladrey Letter;
PWC Letter; SIFMA Letter; Van Kampen/Invesco Letter.
\406\ See ABA Letter; CAI Letter; CAQ Letter; Deloitte Letter;
E&Y Letter; Grant Thornton Letter; KPMG Letter; McGladrey Letter;
PWC Letter; Van Kampen/Invesco Letter.
\407\ See Deloitte Letter.
\408\ See KPMG Letter. See also PCAOB Interim Attestation
Standard, AT Section 101 at ] .13.
\409\ See PWC Letter. See also PCAOB Interim Attestation
Standard, AT Section 101 at ]] .11-.13.
\410\ See E&Y Letter.
\411\ See, e.g., ABA Letter; E&Y Letter; McGladrey Letter.
\412\ See Van Kampen/Invesco Letter.
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In addition, one commenter asked whether the notification
provisions apply to a review of the exemption report.\413\ Another
commenter stated that a report of non-compliance also will trigger a
Rule 17a-11 notice, which would be duplicative and create
confusion.\414\
---------------------------------------------------------------------------
\413\ See KPMG Letter.
\414\ See ABA Letter.
---------------------------------------------------------------------------
iii. The Final Rule
In part in response to comments received, and to achieve
consistency with other revisions to the proposed rule amendments
described above, the notification provisions in the final rule have
been modified from the proposed amendments.\415\ First, the Commission
is persuaded by comments received that the primary obligation to notify
the Commission should remain with the broker-dealer.\416\ Therefore,
the notification process in place before today's amendments generally
has been retained.
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\415\ See paragraph (h) of Rule 17a-5.
\416\ As the proposal noted, the proposed amendment to require
the independent public accountant to notify the Commission directly
of material non-compliance would have been consistent with the
surprise examination notification requirement in Rule 206(4)-2 under
the Advisers Act. A surprise examination of an investment adviser by
an independent public accountant generally verifies that client
funds and securities of which the investment adviser has custody are
held by a qualified custodian, such as a bank or broker-dealer. The
accountant's surprise examination report opines on the adviser's
compliance with the custody rule requirement that client funds and
securities are maintained by a qualified custodian and also opines
on the adviser's compliance with certain recordkeeping obligations
between surprise examinations. The difference in nature and scope of
custodial and other activities between broker-dealers and advisers
results in significantly broader examination requirements for
broker-dealers. Broker-dealers are required to undergo an annual
examination by an independent public accountant of their financial
statements and certain supporting schedules: A computation of net
capital under Rule 15c3-1, a computation for determining reserve
requirements under Rule 15c3-3, and information relating to the
possession and control requirements of Rule 15c3-3. Moreover, under
today's amendments, the independent public accountant must examine
the compliance report of broker-dealers that maintain custody of
customer funds or securities. The differences in the overall nature
of an examination also supports continuing to maintain today's model
under which a broker-dealer has the primary notification obligation
(e.g., unlike in the case of a surprise examination of an investment
adviser, a broker-dealer would already be making its own assessment
and preparing its own report in the case of a compliance report
examination). Further, the Dodd-Frank Act provided the PCAOB with
explicit authority to, among other things, establish (subject to
Commission approval) auditing and related attestation, quality
control, ethics, and independence standards for registered public
accounting firms with respect to their preparation of audit reports
to be included in broker-dealer filings with the Commission, and the
authority to conduct and require an inspection program of registered
public accounting firms that audit broker-dealers. The PCAOB
oversight of broker-dealer examinations provides additional
regulatory oversight with respect to the examination of the broker-
dealer further supporting the retention of the primary obligation
with the broker-dealer to provide notice to the Commission and the
broker-dealer's DEA.
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Second, the final rule amendments require that, if the independent
public accountant determines that the broker-dealer ``is not in
compliance with'' any of the financial responsibility rules during the
course of preparing the accountant's reports, the independent public
accountant must immediately notify the broker-dealer's CFO of the
nature of the non-compliance.\417\ As proposed, the independent public
accountant would have been required to provide notification if the
accountant determined that any ``material non-compliance'' existed. As
discussed above in section II.D.3. of this release, the final rule does
not include a definition of the term material non-compliance, as in the
proposal. Thus, the independent public accountant will be required to
provide notification to the broker-dealer of all instances of non-
compliance with the financial responsibility rules as opposed to the
proposal, which required the independent public accountant to report to
the Commission and the DEA only instances of material non-compliance.
While this may increase the number of times the independent public
accountant must provide notification of non-compliance with the
financial responsibility rules, the independent public accountant will
not have to analyze whether an instance of non-compliance is ``material
non-compliance'' under the proposed definition.
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\417\ Id. Under the current provisions of paragraph (h) of Rule
17a-5 (which are being amended), the independent public accountant
``shall call it to the attention'' of the CFO of the broker-dealer
any material inadequacies. See 17 CFR 240.17a-5(h)(2). In the final
rule, the independent public accountant is required to ``immediately
notify'' the CFO of the ``nature'' of any non-compliance with the
financial responsibility rules or material weakness. This change
from the current notification requirement is designed to make the
rule more clear as ``shall call it to the attention'' does not
specify when the notification must be given. Further, as proposed,
the independent public accountant would have been required to
provide the Commission with notice of any material non-compliance
within one business day of determining that the material non-
compliance exists. See Broker-Dealer Reports, 76 FR at 37606. Under
the final rule, the independent public accountant provides notice to
the broker-dealer's CFO of any non-compliance with the financial
responsibility rules or material weakness and the CFO, in turn, is
required to provide the Commission and other securities regulators
with notice if the non-compliance requires notice under Rule 15c3-1,
Rule 15c3-3, or Rule 17a-11 or in the case of a material weakness.
Consequently, because there is an intermediate step before the
Commission receives notice, it is important that the independent
public accountant notify the CFO immediately so that the Commission
and other securities regulators receive timely notice.
---------------------------------------------------------------------------
If the independent public accountant provides notice to the broker-
dealer of an instance of non-compliance with the financial
responsibility rules, the broker-dealer must provide notice to the
Commission and its DEA in accordance with the notification provisions
of Rule 15c3-1, Rule 15c3-3, or Rule 17a-11, but only if the notice
provided by the independent public accountant concerns an instance of
non-compliance that requires the broker-dealer to provide notification
under those rules. The proposal would have required the accountant to
notify the Commission ``upon determining that any material non-
compliance exists.'' \418\ Rule 15c3-1, Rule 15c3-3, and Rule 17a-11
specify instances of non-compliance that require notification by the
broker-dealer, and paragraph (h) of Rule 17a-5, as amended, refers to
the notification provisions in those rules.
---------------------------------------------------------------------------
\418\ See Broker-Dealer Reports, 76 FR at 37606.
---------------------------------------------------------------------------
The broker-dealer must provide a copy of the notification to the
accountant within one business day and, if the accountant does not
receive the notice or the accountant does not agree with any statements
in the notice, the accountant must provide a report to the Commission
and the broker-dealer's
[[Page 51939]]
DEA within one business day.\419\ The report from the accountant must,
if the broker-dealer failed to file a notification, describe any
instances of non-compliance that required the broker-dealer to provide
a notification.\420\ If the broker-dealer filed a notification but the
independent public accountant does not agree with the statements in the
notice, the report from the accountant must detail the aspects of the
notification of the broker-dealer with which the accountant does not
agree.\421\ This notification process is generally the same as that in
place before today's amendments.
---------------------------------------------------------------------------
\419\ See paragraph (h) of Rule 17a-5.
\420\ Id.
\421\ Id.
---------------------------------------------------------------------------
While the final rule incorporates the existing notification
process, the Commission wants to emphasize the importance of broker-
dealers providing notification to the Commission and other securities
regulators of non-compliance with Rule 15c3-1 as required by Rule 17a-
11 and non-compliance with paragraph (e) of Rule 15c3-3 as required by
paragraph (i) of Rule 15c3-3.\422\ Consequently, the Commission is
adding a note to paragraph (h) of Rule 17a-5 calling the attention of
the broker-dealer and independent public accountant to these
notification requirements.\423\ Further, an important element of this
process is the back-up provided by the independent public accountant in
terms of the obligation under the rule to provide the Commission and
DEA with notification of the instance of non-compliance if the
accountant does not receive a copy of the broker-dealer's notification
or the accountant does not agree with the statements in the
notification. Therefore, of necessity, the independent public
accountant would have to have measures in place to determine whether,
and if so when, the accountant received a copy of the notification
required to be provided by the broker-dealer to the Commission or the
broker-dealer's DEA. An independent public accountant could decide not
to rely solely on the receipt of a copy of the notice from the broker
dealer and take other steps to check whether the broker-dealer provided
notice to the Commission and the DEA, such as obtaining a copy of a
facsimile transmission from the broker-dealer to the Commission and
DEA.
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\422\ Paragraph (b)(1) of Rule 17a-11 provides, among other
things, that every broker-dealer whose net capital declines below
the minimum amount required pursuant to Rule 15c3-1 shall give
notice of such deficiency that same day in accordance with paragraph
(g) of Rule 17a-11 and that the notice shall specify the broker-
dealer's net capital requirement and its current amount of net
capital. See 17 CFR 240.17a-11(b)(1). Paragraph (g) of Rule 17a-11
provides, among other things, that the notice shall be given or
transmitted to the principal office of the Commission in Washington,
DC, the regional office of the Commission for the region in which
the broker-dealer has its principal place of business, the DEA of
which such broker-dealer is a member, and the CFTC if the broker-
dealer is registered as a futures commission merchant with such
Commission, and that the notice shall be given or transmitted by
telegraphic notice or facsimile transmission. See 17 CFR 240.17a-
11(g). Paragraph (i) of Rule 15c3-3 provides that if a broker-dealer
shall fail to make a reserve bank account or special account
deposit, as required by Rule 15c3-3, the broker-dealer shall by
telegram immediately notify the Commission and the regulatory
authority for the broker-dealer, which examines such broker-dealer
as to financial responsibility and shall promptly thereafter confirm
such notification in writing. See 17 CFR 240.15c3-3(i). The
Commission staff is considering ways to modernize the process by
which broker-dealers file these and other notices with the
Commission.
\423\ See note to paragraph (h) of Rule 17a-5, as adopted.
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Third, the proposal has been modified to add that, if the
accountant determines in connection with the audit of a carrying
broker-dealer's annual reports that any material weakness (as defined
in paragraph (d)(3)(iii) of Rule 17a-5) exists, the independent public
accountant must immediately notify the broker-dealer's CFO of the
nature of the material weakness.\424\ As discussed above, before
today's amendments, paragraph (h)(2) of Rule 17a-5 required the
accountant to notify the broker-dealer's CFO if the accountant
determined that any ``material inadequacies'' existed. However, as
explained above in section II.B.3. of this release, the final rules do
not contain the concept of material inadequacy. Also, as the term
material weakness is defined with respect to the compliance report,
this notification requirement only applies to carrying broker-dealers,
whereas the requirement to provide notification of a material
inadequacy applied to carrying and non-carrying broker-dealers.
---------------------------------------------------------------------------
\424\ See paragraph (h) of Rule 17a-5.
---------------------------------------------------------------------------
As discussed in more detail below in section II.F.2. of this
release, the Commission is amending Rule 17a-11 to provide that a
broker-dealer must provide notification to the Commission and its DEA
if the broker-dealer discovers, or is notified by its independent
public accountant, of the existence of a material weakness.\425\
Paragraph (h) of Rule 17a-5, as stated above, requires that the
independent public accountant notify the broker-dealer if the
accountant determines that a material weakness exists.\426\ The rule
also requires the broker-dealer to provide notice in accordance with
the provisions of Rule 17a-11, which, among other things, require the
broker-dealer to provide notice to the Commission and its DEA in
accordance with paragraph (g) of Rule 17a-11 within 24 hours and
transmit a report within 48 hours of the notice stating what the
broker-dealer has done or is doing to correct the situation.\427\
Paragraph (h) of Rule 17a-5 requires the broker-dealer to provide the
accountant with a copy of the notice it sends to the Commission within
one business day and, if the accountant does not receive the notice or
the accountant does not agree with the statements in the notice, the
accountant must provide a report to the Commission and the broker-
dealer's DEA within one business day.\428\ The report from the
accountant must, if the broker-dealer failed to file a notification,
describe any material weakness.\429\ If the broker-dealer filed a
notification and the accountant does not agree with the statements in
the notification, the report from the accountant must detail the
aspects of the notification of the broker-dealer with which the
accountant does not agree.\430\ Again, this notification process is
generally the same as the one in place before today's amendments.\431\
In response to the comment that the rule should require simultaneous
notice by the accountant to the Commission and to the firm's
management, the notification procedures adopted today require that the
accountant notify management of the broker-dealer and also ensure that
the Commission receives timely notice.
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\425\ See paragraph (e) of Rule 17a-11.
\426\ See paragraph (h) of Rule 17a-5.
\427\ See paragraph (h) of Rule 17a-5; 17 CFR 240.17a-11(g).
\428\ See paragraph (h) of Rule 17a-5.
\429\ Id.
\430\ Id.
\431\ One change from the current rule (which is being amended)
is to provide that required actions be completed within ``one
business day'' as opposed to within a ``24 hour period.'' This
change is designed to account for non-business days during which
certain actions may not be feasibly completed.
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As stated above, one commenter asked whether the notification
provisions apply to a review of an exemption report.\432\ The
notification provisions in paragraph (h) of Rule 17a-5 with respect to
non-compliance with the financial responsibility rules apply regardless
of whether the independent public accountant is engaged to prepare a
report based on examination of a broker-dealer's compliance report or a
review of a broker-dealer's exemption report.\433\ An independent
public accountant may determine that a broker-dealer is not in
compliance with a requirement in the financial responsibility rules
(e.g., not in compliance with Rule 15c3-1) during
[[Page 51940]]
the course of an audit engagement of a non-carrying broker-dealer that
files an exemption report either as part of the examination of the
broker-dealer's financial statements or the review of certain
statements the broker-dealer's exemption report. In this case, the
independent public accountant would need to immediately notify the CFO
of the broker-dealer of the nature of the non-compliance. The
notification provisions with respect to an instance of material
weakness only apply to broker-dealers that file a compliance report
because material weakness is defined for purposes of the compliance
report.
---------------------------------------------------------------------------
\432\ See KPMG Letter.
\433\ See paragraph (h) of Rule 17a-5.
---------------------------------------------------------------------------
The rule as amended does not require the accountant to notify the
Commission directly when the accountant determines that a non-
compliance with the financial responsibility rules exists, which
eliminates the concern of a commenter that a report of non-compliance
by the accountant, as proposed, would also trigger a Rule 17a-11
notice, which would be duplicative and create confusion.\434\ As
adopted, the responsibility to provide notification rests with the
broker-dealer in the first instance.
---------------------------------------------------------------------------
\434\ See ABA Letter.
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2. Conforming and Technical Amendments to Rule 17a-11
Before today's amendments, paragraph (e) of Rule 17a-11 provided
that whenever a broker-dealer discovered, or was notified by an
independent public accountant, pursuant to paragraph (h)(2) of Rule
17a-5 or paragraph (f)(2) of Rule 17a-12 of the existence of any
material inadequacy as defined in paragraph (g) of Rule 17a-5 or
paragraph (e)(2) of Rule 17a-12, the broker-dealer was required to give
notice to the Commission within 24 hours of the discovery or
notification and transmit a report to the Commission within 48 hours of
the notice stating what the broker-dealer has done or was doing to
correct the situation.\435\ The Commission proposed amending paragraph
(e) of Rule 17a-11 to delete the references to Rule 17a-5 and to
correct the references to Rule 17a-12.\436\
---------------------------------------------------------------------------
\435\ See 17 CFR 240.17a-11(e).
\436\ See Broker-Dealer Reports, 76 FR at 37579. Rule 17a-12
contains reporting requirements for over-the-counter (``OTC'')
derivatives dealers. See 17 CFR 240.17a-12. The rule is similar to
Rule 17a-5. Compare 17 CFR 240.17a-12, with 17 CFR 240.17a-5. For
example, paragraph (h)(2) of Rule 17a-12 describes material
inadequacies and paragraph (i)(2) of Rule 17a-12 provides that if
the accountant determines that any material inadequacy exists, the
accountant must call it to the attention of the CFO of the OTC
derivatives dealer, who must inform the Commission. See 17 CFR
240.17a-12(h)(2) and (i). The Commission did not propose amending
Rule 17a-12. Consequently, Rule 17a-12 retains the concept of
material inadequacy.
---------------------------------------------------------------------------
One commenter stated that the current notification process under
paragraph (h)(2) of Rule 17a-5 and paragraph (e) of Rule 17a-11
satisfies the objective of notifying the Commission in a timely manner
and that the commenter was concerned that the proposal could undermine
the effectiveness of the notification process in part because it would
require notice to the Commission only when the accountant determines
that there is a deficiency, and not when it is independently discovered
by the broker-dealer.\437\
---------------------------------------------------------------------------
\437\ See Deloitte Letter.
---------------------------------------------------------------------------
The Commission agrees with the commenter that notification should
be provided to the Commission when a deficiency in internal control is
discovered by the broker-dealer, in addition to when it is notified by
its accountant of the existence of any material weakness. Therefore,
the final rule retains references to Rule 17a-5 in paragraph (e) of
Rule 17a-11. The Commission is conforming paragraph (e) of Rule 17a-11
to today's amendments to Rule 17a-5 to substitute the term material
weakness as defined in paragraph (d)(3)(iii) of Rule 17a-5 for the term
material inadequacy with respect to Rule 17a-5 and to replace the
reference to paragraph (h)(2) of Rule 17a-5 with a reference to
paragraph (h) of Rule 17a-5. Specifically, the final rule provides that
whenever a broker-dealer discovers, or is notified by its accountant
under paragraph (h) of Rule 17a-5 of the existence of any material
weakness, the broker-dealer must: (1) Give notice of the material
weakness within 24 hours of the discovery or notification; and (2)
transmit a report within 48 hours of the notice stating what the broker
or dealer has done or is doing to correct the situation.\438\ The rule
retains a reference to material inadequacy as defined in paragraph
(h)(2) of Rule 17a-12, but the amendments correct citations to that
rule.
---------------------------------------------------------------------------
\438\ See paragraph (e) of Rule 17a-11. As stated above, this
provision only applies to broker-dealers that file compliance
reports, as the tern material weakness is defined with respect to
the compliance report.
---------------------------------------------------------------------------
G. Other Amendments to Rule 17a-5
1. Information Provided to Customers--Paragraph (c) of Rule 17a-5
i. Background
Paragraph (c) of Rule 17a-5 generally requires a broker-dealer that
carries customer accounts to send its balance sheet with appropriate
notes and certain other financial information to each of its customers
twice a year.\439\ The Commission did not propose to amend this
requirement. Accordingly, a broker-dealer that carries customer
accounts must continue to send its customers: (1) An audited balance
sheet with footnotes, including a footnote specifying the amount of the
broker-dealer's net capital and required net capital, under paragraph
(c)(2) of Rule 17a-5; \440\ and (2) an unaudited balance sheet dated
six months after the date of the audited balance sheet with footnotes,
including a footnote regarding the amount of the broker-dealer's net
capital and required net capital, under paragraph (c)(3) of Rule 17a-
5.\441\ The information required by paragraphs (c)(2) and (c)(3) of
Rule 17a-5 must either be mailed to customers, or, if the broker-dealer
meets certain conditions under paragraph (c)(5) of Rule 17a-5, the
broker-dealer can semi-annually send its customers summary information
regarding its net capital, as long as it also provides customers with a
toll-free number to call for a free copy of its balance sheet with
appropriate notes, makes its balance sheet with appropriate notes
available to customers on its Web site, and meets other specified
requirements.\442\
---------------------------------------------------------------------------
\439\ See 17 CFR 240.17a-5(c).
\440\ 17 CFR 240.17a-5(c)(2).
\441\ 17 CFR 240.17a-5(c)(3).
\442\ See 17 CFR 240.17a-5(c)(5). See also Broker-Dealer
Exemption from Sending Certain Financial Information to Customers,
Exchange Act Release No. 48282 (Aug. 1, 2003), 68 FR 46446 (Aug. 6,
2003).
---------------------------------------------------------------------------
ii. Availability of Independent Public Accountant's Comments on
Material Inadequacies--Paragraph (c)(2) of Rule 17a-5
Prior to today's amendments, paragraph (c)(2)(iii) of Rule 17a-5
provided that if, in conjunction with a broker-dealer's most recent
audit report, the broker-dealer's independent public accountant
commented on any material inadequacies in the broker-dealer's internal
controls, its accounting system, or certain of its practices and
procedures \443\ under paragraphs (g) and (h) of Rule 17a-5, and
paragraph (e) of Rule 17a-11, the broker-dealer's audited statements
sent to customers were required to include a statement that a copy of
the auditor's comments were available for inspection at the
Commission's principal office in Washington, DC, and the regional
office of the Commission in which the broker-
[[Page 51941]]
dealer had its principal place of business.\444\
---------------------------------------------------------------------------
\443\ These practices and procedures include, for example,
periodic net capital computations under Rule 15c3-1 and periodic
counts of securities under Rule 17a-13.
\444\ See 17 CFR 240.17a-5(c)(2)(iii).
---------------------------------------------------------------------------
As discussed above in sections II.D.3. and II.F. of this release,
the Commission proposed deleting references to, and the definition of,
the term material inadequacy in Rule 17a-5, and proposed amending
paragraph (h) of Rule 17a-5 to require a broker-dealer's independent
public accountant to notify the Commission and the broker-dealer's DEA
if the accountant determined that any material non-compliance existed
at the broker-dealer during the course of preparing its reports.\445\
Consequently, the Commission proposed replacing paragraph (c)(2)(iii)
of Rule 17a-5, which contained the term material inadequacies, with a
requirement that, if a broker-dealer's accountant provided notice to
the Commission of an instance of material non-compliance, the financial
information sent to customers under paragraph (c)(2) of Rule 17a-5 must
include a statement that a copy of the accountant's notice was
available for customers' inspection at the principal office of the
Commission in Washington, DC.\446\ Under this proposal, notices to the
Commission regarding an accountant's determination that one or more
instances of material non-compliance existed at a broker-dealer would
be publicly available.
---------------------------------------------------------------------------
\445\ See Broker-Dealer Reports, 76 FR at 37579.
\446\ This proposal would have been codified in paragraph
(c)(2)(iv) of Rule 17a-5 as a result of paragraph (c)(2)(iii) being
removed and paragraph (c)(2)(iv) being redesignated as paragraph
(c)(iii). See Broker-Dealer Reports, 76 FR at 37603.
---------------------------------------------------------------------------
Three commenters responded to the proposed amendments to paragraph
(c)(2) of Rule 17a-5.\447\ These commenters each stated that the
Commission should accord confidential treatment to accountants' notices
to the Commission regarding determinations of material non-
compliance.\448\ One commenter stated that due to the technical nature
of the financial responsibility rules, there was a risk that notices of
material non-compliance could be misinterpreted by the media and
others.\449\
---------------------------------------------------------------------------
\447\ See ABA Letter; CAI Letter; Deloitte Letter.
\448\ Id.
\449\ See ABA Letter.
---------------------------------------------------------------------------
The Commission is revising its proposal to amend paragraph (c)(2)
of Rule 17a-5 to be consistent with the new notification provisions in
paragraph (h) described above relating to the identification by a
broker-dealer's accountant of a material weakness rather than an
instance of material non-compliance.\450\ Specifically, if, in
connection with the most recent annual reports, the report of the
independent public accountant covering the broker-dealer's compliance
report identifies a material weakness, the broker-dealer must include a
statement that one or more material weaknesses have been identified and
that a copy of the report of the independent public accountant is
currently available for the customer's inspection at the principal
office of the Commission in Washington, DC, and the regional office of
the Commission for the region in which the broker-dealer has its
principal place of business.\451\
---------------------------------------------------------------------------
\450\ See paragraph (c)(2)(iv) of Rule 17a-5.
\451\ Id.
---------------------------------------------------------------------------
In response to commenters' concerns about making the report of
material non-compliance available to the public, the report that now
will be made publicly available is a report that identifies the
existence of a material weakness--not a report of material non-
compliance. In addition, making the report of the independent public
accountant covering the compliance report publicly available if it
identifies the existence of a material weakness is consistent with the
previous treatment of a report of a material inadequacy. Providing
customers notice of an accountant's finding that goes directly to the
financial and operational condition of their broker-dealer and making
the report containing the finding publicly available will make
available to customers information that facilitates their ability to
make more informed decisions in selecting broker-dealers through which
they prefer to conduct business. For these reasons, the final rule does
not accord confidential treatment to a report of an independent public
accountant covering the compliance report if it identifies a material
weakness as some commenters suggested should be the case with respect
to the proposed--but not adopted--report of material non-compliance.
Consequently, an independent public accountant's report covering the
compliance report will be made available for the customer's inspection
at the principal office of the Commission in Washington, DC, and the
regional office of the Commission for the region in which the broker-
dealer has its principal place of business if the report identifies the
existence of a material weakness.\452\
---------------------------------------------------------------------------
\452\ Paragraph (c)(2)(iv) of Rule 17a-5, as adopted, includes
both the principal office of the Commission in Washington, DC and
the regional office of the Commission for the region in which a
broker-dealer has its principal place of business as locations where
the accountant's reports are available. Including the applicable
regional office of the Commission as a location where these notices
are available will make them more accessible to customers and is
consistent with the previous treatment of material inadequacy
reports.
---------------------------------------------------------------------------
iii. Exemption From Mailing Financial Information to Customers--
Paragraph (c)(5) of Rule 17a-5
Before today's amendments, paragraph (c)(5) of Rule 17a-5 provided
a conditional exemption from the requirement that a broker-dealer send
paper copies of financial information to customers if the broker-dealer
mailed to customers a financial disclosure statement with summary
information and an Internet link to its balance sheet and other
information on the broker-dealer's Web site.\453\ One of the conditions
of the exemption, contained in paragraph (c)(5)(vi) of Rule 17a-5, was
that the broker-dealer was not required by paragraph (e) of Rule 17a-11
to give notice of a material inadequacy during the prior year. The
Commission proposed revising the condition in paragraph (c)(5)(vi) of
Rule 17a-5 to provide that the broker-dealer's financial statements
must receive an unqualified opinion from the independent public
accountant and neither the broker-dealer, under proposed paragraph (d)
of Rule 17a-5, nor the independent public accountant, under proposed
paragraph (g) of Rule 17a-5, identified a material weakness or an
instance of material non-compliance.\454\
---------------------------------------------------------------------------
\453\ 17 CFR 240.17a-5(c)(5).
\454\ See Broker-Dealer Reports, 76 FR at 37577.
---------------------------------------------------------------------------
The Commission received several comments on the proposal.\455\ One
commenter stated that broker-dealers should be able to deliver the
financial information available to customers via its Web site
regardless of whether an instance of material non-compliance or
material weakness was identified.\456\ Another commenter stated that
the rule should not require a 100% rate of compliance with the
financial responsibility rules to qualify for the exemption.\457\ A
third commenter stated that the proposed amendment should be
eliminated, or replaced with the requirement that broker-dealers
include a notice of the material weakness or non-compliance on customer
account
[[Page 51942]]
statements for a year following its identification.\458\
---------------------------------------------------------------------------
\455\ See ABA Letter; CAI Letter; SIFMA Letter.
\456\ See ABA Letter.
\457\ See CAI Letter. This commenter stated that as FINRA has
proposed that broker-dealers send customer account statements
monthly instead of quarterly, broker-dealers are already potentially
facing ``extremely high'' costs of sending information to customers.
FINRA withdrew its proposals to send customer account statements
monthly instead of quarterly on July 30, 2012. See Proposed Rule
Change to Adopt FINRA Rule 2231 (Customer Account Statements) in the
Consolidated FINRA Rulebook, File No. SR-2009-028, (July 30, 2012),
available at https://www.finra.org/web/groups/industry/@ip/@reg/@rulfil/documents/rulefilings/p143262.pdf (withdrawal of proposed
rule change).
\458\ See SIFMA Letter.
---------------------------------------------------------------------------
In response to comments received, the Commission has decided not to
adopt the proposed condition in paragraph (c)(5)(vi) of Rule 17a-5 for
qualifying for the conditional exemption. Requiring paper delivery of
financial information to customers when a broker-dealer's financial
statements do not receive an unqualified opinion from its independent
public accountant, or when the broker-dealer fails to comply with
certain regulatory requirements, will not necessarily result in a more
effective means of communication to customers and runs counter to the
dominant trend toward electronic communications between financial
entities and their customers. Further, as discussed above, if a broker-
dealer or its independent public accountant provides notice to the
Commission of a material weakness in the broker-dealer's Internal
Control Over Compliance, paragraph (c)(2)(iv) of Rule 17a-5 as adopted
requires the broker-dealer to include with the semi-annual financial
disclosure statement it sends its customers a statement that the
independent public accountant identified a material weakness and that a
copy of the report of the independent public accountant is available
for the customers' inspection.
2. Technical Amendments
i. Deletion of Paragraph (b)(6) of Rule 17a-5
Before today's amendments, paragraph (b)(6) of Rule 17a-5 provided
that ``a copy of [a broker-dealers] annual audit report shall be filed
at the regional office of the Commission for the region in which the
broker or dealer has its principal place of business and the principal
office of the designated examining authority for said broker or dealer.
Two copies of said report shall be filed at the Commission's principal
office in Washington, DC. Copies thereof shall be provided to all self-
regulatory organizations of which said broker or dealer is a member.''
The Commission proposed to delete this paragraph because the same
provisions are in paragraph (d)(6) of Rule 17a-5.\459\ The Commission
received no comments on this proposal and is deleting paragraph (b)(6)
of Rule 17a-5 as proposed.
---------------------------------------------------------------------------
\459\ See Broker-Dealer Reports, 76 FR at 37593. As discussed
above in section II.B.6. of this release, the Commission is amending
paragraph (d)(6) of Rule 17a-5 to require that a copy of a broker-
dealer's annual report must be filed with SIPC. Specifically, the
Commission is amending paragraph (d)(6) to provide that a broker-
dealer's annual reports ``must be filed at the regional office of
the Commission for the region in which the broker or dealer has its
principal place of business, the Commission's principal office in
Washington, DC, the principal office of the designated examining
authority for the broker or dealer, and with the Securities Investor
Protection Corporation (`SIPC') if the broker or dealer is a member
of SIPC. Copies of the reports must be provided to all self-
regulatory organizations of which the broker or dealer is a member,
unless the self-regulatory organization by rule waives this
requirement.''
---------------------------------------------------------------------------
ii. Deletion of Provisions Relating to the Year 2000
Before today's amendments, paragraph (e)(5) of Rule 17a-5 required
broker-dealers to file Form BD-Y2K. Form BD-Y2K elicited information
with respect to a broker-dealer's readiness for the year 2000 and any
potential problems that could arise with the advent of the new
millennium.\460\ Form BD-Y2K was required to be filed in April 1999 and
only then. In the proposing release, the Commission proposed to delete
paragraph (e)(5) of Rule 17a-5 in its entirety because the provisions
of that paragraph are now moot.\461\ The Commission received no
comments on this proposal and is deleting paragraph (e)(5) of Rule 17a-
5 as proposed.
---------------------------------------------------------------------------
\460\ See Reports to be Made by Certain Brokers and Dealers,
Exchange Act Release No. 40608 (Oct. 28, 1998), 63 FR 59208 (Nov. 3,
1998).
\461\ See Broker-Dealer Reports, 76 FR at 37593.
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iii. Deletion of Paragraph (i)(5) of Rule 17a-5
In the proposing release, the Commission proposed to delete
paragraph (i)(5) of Rule 17a-5, which, before today's amendments,
provided that ``the terms audit (or examination), accountant's report,
and certified shall have the meanings given in Sec. 210.1-02 of this
chapter.'' \462\ The Commission received no comments on this proposal
and is deleting paragraph (i)(5) of Rule 17a-5 as proposed.
---------------------------------------------------------------------------
\462\ Id. at 37594.
---------------------------------------------------------------------------
iv. Amendments to Paragraph (f)(2) of Rule 17a-5
Before today's amendments, paragraph (f)(2) of Rule 17a-5 provided
that a broker-dealer that was required to file an annual audit report
must file a statement with the Commission and its DEA that it has
designated an independent public accountant responsible for performing
the annual audit of the broker-dealer, which was called ``Notice
pursuant to Rule 17a-5(f)(2)''.\463\ Paragraph (f)(2)(iii) of Rule 17a-
5 prescribed the items that were required to be included in the notice:
the name, address, telephone number and registration number of the
broker-dealer; the name, address and telephone number of the accounting
firm; and the audit date of the broker-dealer for the year covered by
the agreement.\464\
---------------------------------------------------------------------------
\463\ See 17 CFR 240.17a-5(f)(2).
\464\ See 17 CFR 240.17a-5(f)(2)(iii)(A)-(C).
---------------------------------------------------------------------------
In addition to the proposed amendments discussed below in section
III. of this release, the Commission proposed certain technical
amendments to paragraph (f)(2) of Rule 17a-5.\465\ First, the
Commission proposed amending the language in paragraph (f)(2)(i) of
Rule 17a-5 to streamline the paragraph and to add a reference to
proposed paragraph (f)(2)(ii) of Rule 17a-5, which would have
prescribed the information a broker-dealer would have been required to
include in its notice designating its accountant. In addition, the
Commission proposed to amend paragraph (f)(2)(i) of Rule 17a-5 to
require that a broker-dealer include a statement in its notice as to
whether the engagement with its independent public accountant was for a
single year or was of a continuing nature. This statement was
previously required by paragraph (f)(2)(ii) of Rule 17a-5, which the
Commission proposed to delete as part of its revisions to that
paragraph. The Commission did not receive any comments on these
proposed changes and is adopting them as proposed. The Commission also
proposed to retain the annual December 10 filing deadline for the
statements provided pursuant to paragraph (f)(2), but also added the
language ``(or 30 calendar days after the effective date of its
registration as a broker or dealer, if earlier).'' The Commission did
not receive any comments on this amendment and is adopting it as
proposed. In addition, the final rule adds a conforming change to the
date of the statement designating the independent public accountant.
Under the proposal, the statement must be dated ``no later than
December 1.'' Under the final rules, the statement must be dated ``no
later than December 1 (or 20 calendar days after the effective date of
its registration as a broker or dealer, if earlier)'' to make the
timing consistent with the filing deadlines described above.
---------------------------------------------------------------------------
\465\ See Broker-Dealer Reports, 76 FR at 37583-37584, 37605-
37606.
---------------------------------------------------------------------------
As discussed in the proposing release, notices pursuant to
paragraph (f)(2) of Rule 17a-5 currently on file with the Commission do
not contain the representations that are required by the amendments to
paragraph (f)(2) that the Commission is adopting today. Accordingly,
broker-dealers subject to paragraph (f)(2) of Rule 17a-5 (i.e., all
broker-dealers that are required to file audited annual reports) must
file a new ``statement regarding the independent
[[Page 51943]]
public accountant under Rule 17a-5(f)(2).'' \466\ As specified in the
new rule, if the engagement covered by the new statement is of a
continuing nature, no subsequent filing would be required unless and
until the broker-dealer changes its independent public accountant or
amends the engagement with the accountant.\467\
---------------------------------------------------------------------------
\466\ See paragraph (f)(2) of Rule 17a-5.
\467\ See paragraph (f)(2)(i) of Rule 17a-5.
---------------------------------------------------------------------------
v. Further Technical Amendments
In the proposing release, the Commission proposed additional
technical amendments to Rule 17a-5, including changes that would
consistently use the term ``independent public accountant'' throughout
Rule 17a-5 when referring to a broker-dealer's accountant,\468\ to make
the rule gender neutral,\469\ and to replace the term ``balance sheet''
with the term ``Statement of Financial Condition'' in all places where
that term appeared in Rule 17a-5.\470\ These technical amendments were
designed to modernize the language of Rule 17a-5, and to make the rule
easier to understand. The Commission received no comments on these
amendments and is adopting them as proposed.
---------------------------------------------------------------------------
\468\ See Broker-Dealer Reports, 76 FR at 37594.
\469\ Id.
\470\ Id. at 37593.
---------------------------------------------------------------------------
The Commission is making further technical amendments that are
consistent with the Commission's ``plain English'' initiative and do
not substantively affect the requirements of Rule 17a-5.\471\ In
addition, for clarity and consistency throughout Rule 17a-5, the
Commission is amending Rule 17a-5 to replace the words ``date selected
for the annual audit of financial statements'' that were previously
contained in paragraphs (a)(2)(ii) and (iii) of Rule 17a-5 with the
words ``end of the fiscal year of the broker or dealer.'' \472\ The
phrase ``date selected for the annual audit of the financial
statements'' has the same meaning as the phrase ``end of the fiscal
year of the broker or dealer.'' As discussed earlier, this change
eliminates outdated language and conforms the text in paragraph (a) of
Rule 17a-5 to the text in paragraph (n) of Rule 17a-5. The Commission
is making a technical amendment to paragraph (a)(3) of Rule 17a-5. As
proposed, paragraph (a)(3) provided that the reports required under
paragraph (a) of Rule 17a-5 were considered filed when received at the
Commission's principal office and the regional office of the Commission
where the broker-dealer has its principal place of business. However,
Form Custody, which broker-dealers must file under paragraph (a)(5) of
Rule 17a-5, as amended, must be filed with the broker-dealer's DEA and
not with the Commission. The Commission is therefore amending paragraph
(a)(3) of Rule 17a-5 to clarify that this provision applies to reports
``that must be filed with the Commission.'' As a result, the Commission
is making technical amendments to paragraphs (a)(2)(i) through
(a)(2)(iv) of Rule 17a-5 to specify that the FOCUS Reports required
under these provisions must be filed with the Commission.
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\471\ These amendments replace the term ``shall'' with ``must,''
the term ``pursuant to'' with ``under,'' the term ``said'' with
``the'' or ``that,'' the term ``such'' with ``the'' or ``that,'' the
term ``other than'' with ``not,'' and the term ``therewith'' with
``with the.''
\472\ For example, 17 CFR 240.17a-5(a)(5), (d)(3)(i)(B), and
(d)(5) each refer to the ``end of the fiscal year of the broker or
dealer.''
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The Commission also is making technical amendments to paragraph
(m)(1) of Rule 17a-5, which relates to extensions and exemptions for
filing annual reports, and (n)(2) of Rule 17a-5, which relates to a
broker-dealer's notification requirements when changing its fiscal
year, to replace the words ``annual audit reports'' and ``audit
report,'' respectively, with the words ``annual reports.'' The
Commission also is deleting an unnecessary citation to paragraph
(d)(1)(i) of Rule 17a-5 that was previously included in paragraph
(n)(2) of Rule 17a-5.
H. Coordination With Investment Advisers Act Rule 206(4)-2
1. Background
The amendments to Rule 17a-5 that the Commission is adopting today
will permit carrying broker-dealers that either also are registered as
investment advisers or maintain client assets of an affiliated
investment adviser and are subject to the internal control report
requirement in Rule 206(4)-2 to satisfy that requirement with a report
prepared by the broker-dealer's independent public accountant based on
an examination of certain of the broker-dealer's statements in the
compliance report.
2. Rule 206(4)-2
Rule 206(4)-2 provides that a registered investment adviser is
prohibited from maintaining custody of client funds or securities
unless a ``qualified custodian'' maintains those funds and securities:
(1) In a separate account for each client under that client's name; or
(2) in accounts that contain only the investment adviser's clients'
funds and securities, under the investment adviser's name as agent or
trustee for the clients.\473\ Under Rule 206(4)-2, only banks, certain
savings associations, registered broker-dealers, FCMs, and certain
foreign financial institutions may act as qualified custodians.\474\
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\473\ See 17 CFR 275.206(4)-2(a)(1)(i)-(ii).
\474\ See 17 CFR 275.206(4)-2(d)(6).
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In addition, when an investment adviser or its related person
maintains client funds and securities as qualified custodian in
connection with advisory services provided to clients, the adviser
annually must obtain, or receive from its related person, a written
internal control report prepared by an independent public accountant
registered with, and subject to regular inspection by, the PCAOB.\475\
This report must be supported by the independent public accountant's
examination of the qualified custodian's custody controls.\476\
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\475\ Id.
\476\ Rule 206(4)-2 provides that the internal control report
must include an opinion of an independent public accountant as to
whether controls have been placed in operation as of a specific
date, and are suitably designed and are operating effectively to
meet control objectives relating to custodial services, including
the safeguarding of funds and securities held by either the adviser
or its related person on behalf of advisory clients, during the
year. The rule also requires that the accountant ``verify that the
funds and securities are reconciled to a custodian other than [the
adviser or its] related person.'' See 17 CFR 275.206(4)-2.
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The Commission has issued guidance identifying the control
objectives that should be included in the scope of the internal control
examination required under Rule 206(4)-2.\477\ The control objectives
for the Rule 206(4)-2 examination are more general than the specific
operational requirements in the
[[Page 51944]]
financial responsibility rules.\478\ This approach allows different
types of qualified custodians (banks, certain savings associations,
broker-dealers, FCMs, and certain foreign financial institutions) to
establish controls and procedures that meet the identified control
objectives in a manner that reflects differences in business models,
regulatory requirements, and other factors.\479\
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\477\ See Commission Guidance Regarding Independent Public
Accountant Engagements Performed Pursuant to Rule 206(4)-2 Under the
Investment Advisers Act of 1940, Advisers Act Release No. 2969 (Dec.
30, 2009), 75 FR 1492 (Jan. 11, 2010) (identifying the following
specified objectives: (1) Documentation for the opening and
modification of client accounts is received, authenticated, and
established completely, accurately, and timely on the applicable
system; (2) client transactions, including contributions and
withdrawals, are authorized and processed in a complete, accurate,
and timely manner; (3) trades are properly authorized, settled, and
recorded completely, accurately, and timely in the client account;
(4) new securities and changes to securities are authorized and
established in a complete, accurate and timely manner; (5)
securities income and corporate action transactions are processed to
client accounts in a complete, accurate, and timely manner; (6)
physical securities are safeguarded from loss or misappropriation;
(7) cash and security positions are reconciled completely,
accurately and on a timely basis between the custodian and
depositories; and (8) account statements reflecting cash and
security positions are provided to clients in a complete, accurate
and timely manner).
\478\ Compare the control objectives described in Commission
Guidance Regarding Independent Public Accountant Engagements
Performed Pursuant to Rule 206(4)-2 Under the Investment Advisers
Act of 1940, 75 FR at 1494, with the requirements in 17 CFR
240.15c3-1, 17 CFR 240.15c3-3, 17 CFR 240.17a-13, and the DEA
Account Statement Rules.
\479\ See Broker-Dealer Reports, 76 FR at 37580.
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3. Broker-Dealers Acting as Qualified Custodians Under Rule 206(4)-2
Broker-dealers that also are registered as investment advisers may,
acting in their capacity as broker-dealers, maintain client securities
and funds as qualified custodians in connection with advisory services
provided to clients.\480\ As a result of being the adviser and
qualified custodian to its clients, under Rule 206(4)-2 these broker-
dealers must obtain an internal control report relating to the custody
of those assets from an independent public accountant that is
registered with, and subject to regular inspection by, the PCAOB. In
addition, broker-dealers acting as qualified custodians also may
maintain advisory client assets in connection with advisory services
provided by related or affiliated investment advisers. Rule 206(4)-2
requires such a broker-dealer to provide an internal control report to
its related investment adviser.\481\
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\480\ The Commission staff has estimated that approximately 18%
of FINRA-registered broker-dealers also are registered as investment
advisers with the Commission or with a state. See Commission staff,
Study on Investment Advisers and Broker-Dealers, as required by
Section 913 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Jan. 2011).
\481\ See 17 CFR 275.206(4)-2(a)(6). Based on data collected
from the Investment Adviser Registration Depository as of August
2012, close to 200 investment advisers reported on Form ADV that
client assets were being held at a qualified custodian that was
related to the adviser.
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4. Proposal to Allow Report Based on Examination of Compliance Report
to Satisfy Rule 206(4)-2
i. The Proposal
Broker-dealers that maintain custody of customer funds and
securities are subject to specific operational requirements in the
financial responsibility rules with respect to handling and accounting
for customer assets.\482\ The operational requirements of the financial
responsibility rules are consistent with the control objectives
outlined in the Commission's guidance on Rule 206(4)-2.\483\ As a
result of the proposed amendments to Rule 17a-5, the Commission stated
in the proposing release that a broker-dealer subject to an examination
by an independent public accountant of its compliance report that also
acts as a qualified custodian for itself as an investment adviser or
for its related investment advisers under Rule 206(4)-2 would be able
to use the independent public accountant's report resulting from the
examination to satisfy the internal control report requirement under
Rule 206(4)-2.\484\
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\482\ While Rule 15c3-1 prescribes broker-dealer net capital
requirements, it also contains provisions relating to custody. For
example, a broker-dealer must take net capital charges for short
security differences unresolved after specifically enumerated
timeframes. See 17 CFR 240.15c3-1(c)(2)(v)(A).
\483\ See Broker-Dealer Reports, 76 FR at 37579-37580;
Commission Guidance Regarding Independent Public Accountant
Engagements Performed Pursuant to Rule 206(4)-2 Under the Investment
Advisers Act of 1940, 75 FR at 1493-1494.
\484\ See Broker-Dealer Reports, 76 FR at 37579-37580.
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ii. Comments on the Proposal
The Commission received several comments regarding the proposal
that the independent public accountant's report based on an examination
of the compliance report would satisfy the internal control report
under Rule 206(4)-2. One commenter stated that it is ``critically
important'' that there be a single independent public accountant
engagement of the custody function at both the broker-dealer and
investment adviser operations of any dually registered entity (or of
affiliated broker-dealers and investment advisers) and that this
engagement use a single, consistent standard for evaluating custody at
both the broker-dealer and investment adviser operations.\485\ Two
commenters noted that there are non-carrying broker-dealers that act as
qualified custodians under the Advisers Act and that these broker-
dealers would not be subject to the proposed compliance report
requirements and, consequently, would not be able to use the report of
the independent public accountant covering the compliance report to
satisfy the internal control report requirement in Rule 206(4)-2
because the broker-dealers would be filing exemption reports instead of
compliance reports.\486\ One commenter characterized this as an area of
redundancy that could be eliminated by allowing an accountant's review
of a non-carrying broker-dealer's transmittal procedures to be
``recognized by the Investment Adviser regulatory regime promulgated by
the Commission.'' \487\
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\485\ See CFP Letter.
\486\ See CAI Letter; Deloitte Letter.
\487\ See Deloitte Letter.
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In addition, two commenters asked for clarification regarding the
interaction of the proposed compliance report requirements with the
requirement in Rule 206(4)-2 that investment advisers undergo an annual
surprise examination by an independent accountant to verify customer
funds and securities held in custody.\488\ Specifically, both asked
that the Commission clarify whether the independent public accountant
performing the surprise examination would be able to place reliance on
the proposed compliance report and related compliance examination to
determine the nature and extent of the procedures for the surprise
examination.\489\ One of the commenters also asked that, if the
Commission clarifies that the independent public accountant performing
the surprise examination is expected to rely on the proposed compliance
report requirements, what factors should the independent public
accountant consider, given that the report based on an examination of
the compliance report would not be required to be completed until 60
days after the fiscal year end while the surprise examination may occur
at any time.\490\
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\488\ See CAQ Letter; PWC Letter. Paragraph (a)(4) of Rule
206(4)-2 requires, among other things, that client funds and
securities of which an investment adviser has custody must be
verified by actual examination at least once during each calendar
year by an independent public accountant, pursuant to a written
agreement between the investment adviser and the accountant, at a
time that is chosen by the accountant without prior notice or
announcement to the investment adviser and that is irregular from
year to year. See 17 CFR 275.206(4)-2.
\489\ See CAQ Letter; PWC Letter.
\490\ See PWC Letter.
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5. Adoption of Proposal Relating to Rule 206(4)-2
As discussed above, under today's amendments, a carrying broker-
dealer must prepare, and file with the Commission and its DEA, a
compliance report on, among other things, its Internal Control Over
Compliance, and must file with the compliance report a report prepared
by its independent public accountant based on an examination of the
compliance report.\491\ As a result of the amendments to Rule 17a-5,
the Commission has determined that the independent public accountant's
report based on an examination of the compliance report
[[Page 51945]]
will satisfy the internal control report requirement under Rule 206(4)-
2 because the operational requirements of the financial responsibility
rules are consistent with the control objectives outlined in the
Commission's guidance on Rule 206(4)-2.\492\ For example, to be able to
include a statement that the broker-dealer has established and
maintained Internal Control Over Compliance (which is defined as
internal controls that have the objective of providing the broker-
dealer with reasonable assurance that non-compliance with the financial
responsibility rules will be prevented or detected on a timely
basis),\493\ a broker-dealer's internal control over compliance with
Rule 17a-13 will result in controls over the safeguarding of securities
from loss or misappropriation and the completeness, accuracy, and
timeliness of the securities reconciliation process.\494\ To make a
similar statement with respect to the Account Statement Rules, a
broker-dealer would of necessity have internal controls over compliance
with the Account Statement Rules designed to ensure that customers
receive complete, accurate, and timely information concerning
securities positions and other assets held in their accounts.\495\ A
statement that the broker-dealer has established and maintained
Internal Control Over Compliance would cover these and other internal
controls over compliance with the financial responsibility rules and
would be examined by the independent public accountant during the
examination of the compliance report.
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\491\ See 17 CFR 240.17a-5(d)(3) and (g)(2)(i).
\492\ See Commission Guidance Regarding Independent Public
Accountant Engagements Performed Pursuant to Rule 206(4)-2 Under the
Investment Advisers Act of 1940, 75 FR at 1494; Broker-Dealer
Reports, 76 FR at 37579-37580. As discussed above in section II.D.3.
of this release, the independent public accountant must examine the
compliance report in accordance with attestation standards
promulgated by the PCAOB. Consequently, the PCAOB's attestation
standards are integral to the Commission's determination that the
independent public accountant's report based on an examination of
the compliance report satisfies the internal control report
requirement under Rule 206(4)-2. The Commission could revisit this
determination if the PCAOB's attestation standards do not support
the determination.
\493\ See paragraphs (d)(3)(i)(A)(1) and (d)(3)(ii) of Rule 17a-
5.
\494\ See 17 CFR 240.17a-13. As discussed above in section
II.D.3. of this release, the PCAOB proposed attestation standards
related to the compliance report. The PCAOB's proposed attestation
standards include a requirement that the independent public
accountant must perform procedures to obtain evidence about the
existence of customer funds or securities held for customers, e.g.,
confirmation of customer security positions directly with
depositories and clearing organizations. See PCAOB Proposing Release
app. 1, at ] 26. This procedure would be consistent with the tests
of the qualified custodian's reconciliation that the Commission
specified in the guidance on Rule 206(4)-2. See Commission Guidance
Regarding Independent Public Accountant Engagements Performed
Pursuant to Rule 206(4)-2 Under the Investment Advisers Act of 1940,
75 FR 1494.
\495\ See, e.g., CBOE Rule 9.12; NASD Rule 2340. See also
Commission Guidance Regarding Independent Public Accountant
Engagements Performed Pursuant to Rule 206(4)-2 Under the Investment
Advisers Act of 1940, Advisers Act Release No. 2969 (Dec. 30, 2009),
75 FR 1494 (Jan. 11, 2010), which describes as a control objective
for qualified custodians (including broker-dealer qualified
custodians) that account statements reflecting cash and security
positions are provided to clients in a complete, accurate and timely
manner.
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As commenters noted, broker-dealers that are not carrying broker-
dealers are not subject to the compliance report requirements and,
therefore, those broker-dealers must comply with the internal control
report requirement in Rule 206(4)-2 if they are subject to that
requirement. The exemption report is not redundant of the internal
control report requirement in Rule 206(4)-2 because, among other
things, the scope of the required statements included in a broker-
dealer's exemption report is different than the scope of the internal
control report requirement in Rule 206(4)-2.\496\
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\496\ See supra notes 299, 300.
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As noted above, commenters also asked whether the accountant would
be able to place reliance on the proposed compliance report and related
examination of the compliance report to determine the nature and extent
of the procedures for the surprise examination. PCAOB attestation
standards require an independent public accountant ``to obtain an
understanding of internal control over compliance sufficient to plan
the engagement and to assess control risk for compliance with specified
requirements.'' \497\ The Commission agrees that the independent public
accountant's understanding of internal controls related to custody at
the broker-dealer acting as a qualified custodian, as well as other
facts and circumstances, may affect the nature and extent of procedures
performed for the annual surprise examination.\498\ The Commission has
provided interpretive guidance on the relationship between the annual
surprise examination and the internal control report for engagements
performed pursuant to Rule 206(4)-2.\499\
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\497\ See PCAOB Interim Attestation Standard, AT Section 601. AT
Section 601 requires an independent public accountant ``to obtain an
understanding of internal control over compliance sufficient to plan
the engagement and to assess control risk for compliance with
specified requirements. In planning the examination, such knowledge
should be used to identify types of potential non-compliance, to
consider factors that affect the risk of material noncompliance, and
to design appropriate tests of compliance.'' Id. at ] .45.
\498\ Id.
\499\ See Commission Guidance Regarding Independent Public
Accountant Engagements Performed Pursuant to Rule 206(4)-2 Under the
Investment Advisers Act of 1940, Advisers Act Release No. 2969 (Dec.
30, 2009), 75 FR 1492 (Jan. 11, 2010).
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III. Access to Accountant and Audit Documentation
The Commission proposed amending paragraph (f)(2) of Rule 17a-5 to
require that each clearing broker-dealer \500\ include a representation
in its statement regarding its independent public accountant that the
broker-dealer agrees to allow Commission and DEA examination staff to
review the audit documentation associated with its annual audit reports
required under Rule 17a-5 and to allow its independent public
accountant to discuss findings relating to the audit reports with
Commission and DEA examination staff if requested for the purposes of
an examination of the broker-dealer.\501\ This proposed requirement was
intended to facilitate examinations of clearing broker-dealers by
Commission and DEA examination staff.\502\ Access to information
obtained from audit documentation and discussions with a clearing
broker-dealer's independent public accountant would enhance the
efficiency and effectiveness of Commission and DEA examinations by
providing examiners with access to additional relevant information to
plan their examinations.\503\
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\500\ For the purpose of this release, a ``clearing broker-
dealer'' is a broker-dealer that clears transactions or carries
customer accounts.
\501\ See Broker-Dealer Reports, 76 FR at 37583-37584.
\502\ Id.
\503\ For example, where an independent public accountant has
performed extensive testing of a carrying broker-dealer's custody of
funds and securities by confirming holdings at custodians and sub-
custodians, examiners could focus their efforts on other matters
that had not been the subject of prior testing and review.
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The Commission proposed to limit this requirement to clearing
broker-dealers, which generally have more complex business operations
than non-carrying firms.\504\ Thus, access to accountants and audit
documentation was considered of substantially greater value when
preparing for regulatory examinations of these types of broker-dealers,
as compared to firms with more limited business models.
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\504\ See Broker-Dealer Reports, 76 FR at 37583.
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To facilitate Commission and DEA examination staff access to a
clearing broker-dealer's independent public accountant and the
accountant's audit documentation, the Commission proposed amending
paragraph (f)(2) of
[[Page 51946]]
Rule 17a-5 to require that a clearing broker-dealer's notice
designating its independent public accountant include, among other
things, representations: (1) That the broker-dealer agrees to allow
representatives of the Commission or the broker-dealer's DEA, if
requested for purposes of an examination of the broker-dealer, to
review the documentation associated with the reports of its independent
public accountant prepared pursuant to paragraph (g) of Rule 17a-5; and
(2) that the broker-dealer agrees to permit its independent public
accountant to discuss with representatives of the Commission and the
DEA, if requested for the purposes of an examination of the broker-
dealer, the findings associated with the reports of the accountant
prepared pursuant to paragraph (g) of Rule 17a-5.\505\ Proposed
paragraph (f)(2)(iii) of Rule 17a-5 provided that a broker-dealer that
does not clear transactions or carry customer accounts would not be
required to include these representations in its notice.\506\
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\505\ Id.
\506\ Id.
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Eight commenters addressed the proposed changes to paragraph (f)(2)
of Rule 17a-5.\507\ Generally, commenters requested that the Commission
do one or more of the following: (1) Clarify the type of documentation
that the Commission and DEA examiners would seek to access \508\; (2)
grant confidential treatment to documentation obtained by the
Commission under this provision \509\; (3) clarify the process by which
Commission and DEA examiners would seek access to a broker-dealer's
independent public accountant and its audit documentation \510\; and
(4) limit the use of information and documentation obtained from a
broker-dealer's independent public accountant.\511\ In addition, one
commenter raised general concerns that providing Commission and DEA
examiners with access to a broker-dealer's auditor and audit
documentation will discourage communications between broker-dealers and
their auditors and may require auditors to produce documentation
protected by attorney-client and/or accountant-client privilege.\512\
Finally, one commenter asserted that it is reasonable for securities
regulators to be able to validate any concerns promptly with a broker-
dealer's accountant.\513\
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\507\ See CAI Letter; CAQ Letter; CFP Letter; Deloitte Letter;
E&Y Letter; KPMG Letter; PWC Letter; SIFMA Letter.
\508\ See CAQ Letter; Deloitte Letter; E&Y Letter; KPMG Letter.
\509\ See CAI Letter; KPMG Letter; PWC Letter; SIFMA Letter.
\510\ See Deloitte Letter; E&Y Letter; KPMG Letter.
\511\ See E&Y Letter; PWC Letter.
\512\ See CAI Letter.
\513\ See CFP Letter.
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In response to requests for clarity as to the types of audit
documentation that Commission and DEA examiners would seek to access
under the proposal, the Commission revised proposed paragraph
(f)(2)(ii)(F) of Rule 17a-5 to clarify that ``audit documentation'' has
the meaning established by PCAOB standards.\514\ This revision, which
was specifically suggested by two commenters,\515\ is not intended to
alter an independent public accountant's obligations with respect to
audit documentation; rather, it is intended to clarify the types of
audit documentation that the Commission and DEA examiners may ask to
review in connection with a broker-dealer examination.
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\514\ PCAOB Auditing Standard 3 defines ``Audit documentation''
as the ``written record of the basis for the auditor's conclusions
that provides the support for the auditor's representations, whether
those representations are contained in the auditor's report or
otherwise. Audit documentation also facilitates the planning,
performance, and supervision of the engagement, and is the basis for
the review of the quality of the work because it provides the
reviewer with written documentation of the evidence supporting the
auditor's significant conclusions. Among other things, audit
documentation includes records of the planning and performance of
the work, the procedures performed, evidence obtained, and
conclusions reached by the auditor. Audit documentation also may be
referred to as work papers or working papers.''
\515\ See CAQ Letter; KPMG Letter.
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In response to questions regarding the process by which Commission
and DEA examiners might seek to access audit documentation, the
Commission agrees with a commenter that suggested that these requests
be in writing because that will provide independent public accountants
with a record of requests for information and specify the documentation
the Commission or DEA examination staff would like to access.\516\
Therefore, the Commission has modified the rule from the proposal to
provide that a request to a broker-dealer's independent public
accountant for the accountant to discuss audit findings or for access
to audit documentation be made in writing.
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\516\ See KPMG Letter. See also Deloitte Letter, which suggests
that Commission and DEA examiners first provide notice to the
broker-dealer, in writing, of plans to request access to the broker-
dealer's audit documentation and then make a written request to the
accountant. Although, in practice, Commission and DEA examiners may
provide advance or simultaneous notice to a broker-dealer of
requests to access audit documentation from the broker-dealer's
accountant, the Commission is not adopting a requirement that
examiners so notify broker-dealers of such requests. This additional
notification would likely delay an examiner's ability to gain access
to the broker-dealer's audit documentation and is not necessary
given the broker-dealer's prior consent. In addition, a broker-
dealer can request that its accountant provide notice when examiners
request audit documentation, and, expects that, in practice,
accountants will provide such notice. See also E&Y Letter.
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Independent public accountants can seek to protect information
obtained by examiners from being disclosed to Freedom of Information
Act (``FOIA'') requestors by specifically requesting confidential
treatment of audit documentation following the process described in
Rule 83 of the Commission's Rules on Information and Requests.\517\ The
Commission anticipates that it will accord confidential treatment to
such documents to the extent permitted by law.\518\
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\517\ 17 CFR 200.83. Generally, persons who submit information
to the Commission may request that the Commission accord
confidential treatment to the information for any reason permitted
by federal law.
\518\ The Commission believes that this audit documentation
likely would fall under exemptions (b)(8) and/or (b)(4) of FOIA. See
5 U.S.C. 522(b)(8); 5 U.S.C. 522(b)(4).
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Two commenters requested that the Commission clarify the intended
use of information and documents obtained from an independent public
accountant.\519\ One recommended that the Commission clarify that the
information obtained from the independent public accountant not be used
for any purpose other than in connection with a regulatory examination
of the broker-dealer.\520\ The other suggested that the rule text state
that the requests for information should be solely for the purposes of
conducting a regulatory examination of the clearing broker-dealer.\521\
The Commission does not believe that it is necessary to modify the
proposed rule text in response to these comments. The Commission stated
that it did not propose that examiners would use the requested
information for the purpose of inspecting independent public
accountants.\522\ As the Commission stated in the proposing release,
the purpose of this access requirement is to enhance and improve the
efficiency and effectiveness of Commission and DEA examinations of
broker-dealers.\523\ The PCAOB is responsible for inspections of
independent public accountants that audit broker-dealers.\524\ In
response to these comments, the Commission reiterates its intention, as
stated in the proposing release, that any requests for
[[Page 51947]]
audit documentation under this provision would be made exclusively in
connection with conducting a regulatory examination of a broker-
dealer.\525\
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\519\ See E&Y Letter; PWC Letter.
\520\ See PWC Letter.
\521\ See E&Y Letter.
\522\ See Broker-Dealer Reports, 76 FR at 37583.
\523\ Id.
\524\ Id.
\525\ Id.
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One commenter stated that Commission and DEA examiners should be
limited to inspecting audit documentation relating to a broker-dealer
in the offices of the broker-dealer's independent public accountant and
that the broker-dealer should be permitted to be present during
conversations between Commission or DEA staff and the accountant.\526\
The Commission has considered these comments and decided not to modify
the proposal in response to these comments. However, Commission and DEA
examiners may exercise discretion in determining whether to review
audit documentation in the offices of the broker-dealer's accountant
and whether to permit the broker-dealer to be present during
conversations with the accountant. This commenter also requested that
the Commission establish a process by which broker-dealers can object
to overly broad or unduly burdensome requests.\527\ The rule will not
be modified in response to this comment and the Commission recommends
that any concerns regarding the scope of audit documentation requests
be directed to the examiner from whom the request was received. The
examiner will consider the concerns and determine whether and how to
limit the scope of the audit documentation request, if appropriate. The
independent public accountant also can express concerns to senior
examination staff if the scope of the audit documentation request
remains a concern after discussions with the examiner.
---------------------------------------------------------------------------
\526\ See SIFMA Letter.
\527\ Id.
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Another commenter stated that the Commission must be responsible
for returning all audit work papers that it receives for purposes of an
examination of the broker-dealer to either the broker-dealer or its
accountant.\528\ The purpose of requesting access to audit
documentation is to assist examiners in conducting a regulatory
examination of the clearing broker-dealer. Upon completion of the
examination, if the Commission and DEA, and any offices and divisions
thereof, no longer need the audit documentation, the Commission and DEA
will, upon the request of the independent public accountant and in the
absence of unusual circumstances, return audit documentation to the
independent public accountant or the broker-dealer within a reasonable
time after the examination is complete.
---------------------------------------------------------------------------
\528\ See CAI Letter.
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One commenter stated that, if adopted, this requirement will
discourage or ``chill'' communications between a broker-dealer and its
auditor because ``the broker-dealer knows that regardless of the nature
of an auditing issue and how it was discovered . . . it cannot freely
seek advice from, or discuss the issue openly with[] the auditor[]
without fear of the auditor misunderstanding the broker-dealer's
response or simply drawing a conclusion that a broker-dealer's
questions indicate the broker-dealer's lack of knowledge or admission
of an issue.'' \529\ Presumably, this ``chilling effect'' would result
from a broker-dealer's desire to avoid the creation of audit
documentation memorializing misunderstandings and miscommunications,
which, when accessed by Commission and DEA examiners, could result in
regulatory scrutiny. The Commission is not persuaded by this comment;
while it is possible for miscommunications to occur between
representatives of a broker-dealer and its auditor, potential
misunderstandings or miscommunications should not limit the ability of
the Commission or a DEA to have access to audit documentation or a
broker-dealer's independent public accountant. Further, to the extent a
misunderstanding or miscommunication between a broker-dealer and its
accountant is reflected in the accountant's audit documentation
relating to the broker-dealer, the broker-dealer could clarify the
nature of the misunderstanding or miscommunication to examiners and
explain how it was rectified if such clarification and rectification is
not already described in subsequent audit documentation.
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\529\ Id.
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The same commenter also asserted that the requirement that broker-
dealers allow regulators to access audit documentation may, in effect,
require auditors to produce documentation protected by attorney-client
privilege or accountant-client privilege.\530\ The rule language
providing Commission and DEA examiners with access to a broker-dealer's
auditor and audit documentation is not designed to affect the
circumstances in which privilege can be asserted. Any claims of
privilege can be addressed on a case-by-case basis by appropriate
Commission and DEA staff as those claims arise.
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\530\ Id.
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IV. Form Custody
A. Background
Proposed Form Custody was comprised of nine line items (each, an
``Item'') designed to elicit information about a broker-dealer's
custodial activities.\531\ As is discussed below, several Items on the
proposed form contained multiple questions, and some required the
completion of charts and the disclosure of custody-related information
specific to the broker-dealer completing the form.\532\
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\531\ See Broker-Dealer Reports, 76 FR at 37584-37592.
\532\ Id.
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The Commission received nine comment letters on proposed Form
Custody.\533\ While commenters generally supported the proposed form,
the Commission received several comments on the timing of, exemptions
from, and the compliance date for filing the form and whether a broker-
dealer also would be required to file an accountant's attestation
covering the form.\534\ In addition, several commenters suggested that
the Commission make certain revisions to the form and address certain
technical interpretative questions.\535\ One commenter, who agreed ``in
concept'' that Form Custody is appropriate for custodial broker-
dealers, also stated that the aggregate cost estimate of the proposed
form was ``staggering.'' \536\
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\533\ See Angel Letter; Barnard Letter; CAI Letter; CFP Letter;
E&Y Letter; IMS Letter; KPMG Letter; Shatto Letter; SIFMA Letter.
\534\ See CAI Letter; E&Y Letter; KPMG Letter; Shatto Letter;
SIFMA Letter.
\535\ See Angel Letter; CFP Letter; SIFMA Letter.
\536\ See IMS Letter. This commenter, however, did not provide
any suggestion for reducing the costs associated with Form Custody.
See section VII. below for an economic analysis of the costs and
benefits relating to Form Custody.
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The Commission is adopting the requirement that broker-dealers file
Form Custody with their DEAs, subject to modifications that, in part,
respond to issues raised by commenters. A description of the comments
on the proposed process for filing Form Custody is set forth below in
section IV.B. of this release, together with a discussion of the final
rule amendments that the Commission is adopting today. A description of
the comments on the proposed form is set forth below in section IV.C.
of this release, together with a discussion of the final form the
Commission is adopting today.
B. Filing of Form Custody
1. Requirement to File Form Custody with FOCUS Reports
Under paragraph (a) of Rule 17a-5, a broker-dealer is required to
file periodic
[[Page 51948]]
FOCUS Reports with the Commission and the broker-dealer's DEA.\537\ In
the proposing release, the Commission proposed adding paragraph (a)(5)
to Rule 17a-5 to require the filing of Form Custody, which was designed
to elicit information concerning whether a broker-dealer maintained
custody of customer and non-customer assets, and, if so, how such
assets were maintained.\538\ Under this proposed amendment, a broker-
dealer would be required to file Form Custody with its DEA at the same
time it filed its periodic FOCUS Report with its DEA under paragraph
(a) of Rule 17a-5.\539\ The DEA, in turn, would be required to maintain
the information obtained through the filing of Form Custody and to
transmit such information to the Commission at such time as it
transmits FOCUS Report data to the Commission under paragraph (a)(4) of
Rule 17a-5.\540\
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\537\ See 17 CFR 240.17a-5(a); 17 CFR 249.617. FOCUS Reports are
one of the primary means of monitoring the financial and operational
condition of broker-dealers and enforcing the broker-dealer
financial responsibility rules. The completed forms also are used to
determine which firms are engaged in various securities-related
activities and how economic events and government policies might
affect various segments of the securities industry. The FOCUS Report
was designed to eliminate overlapping regulatory reports required by
various SROs and the Commission and to reduce reporting burdens as
much as possible. FOCUS Reports and Form Custody are deemed
confidential under paragraph (a)(3) of Rule 17a-5.
\538\ See Broker-Dealer Reports, 76 FR at 37592. For purposes of
Form Custody, the term ``customer'' means a person that is a
``customer'' for purposes of Rule 15c3-3(a), and a ``non-customer''
means a person other than a ``customer'' as that term is defined in
Rule 15c3-3(a). See 17 CFR 240.15c3-3(a); FINRA, Interpretations of
Financial and Operational Rules, Rule 15c3-3(a)(1)/01, available at
https://www.finra.org/Industry/Regulation/Guidance/FOR/.
\539\ See Broker-Dealer Reports, 76 FR at 37592.
\540\ Id.
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A broker-dealer's FOCUS Report provides the Commission and a
broker-dealer's DEA with information relating to the broker-dealer's
financial and operational condition but does not solicit detailed
information on how a broker-dealer maintains custody of assets.\541\
Proposed Form Custody was intended to provide additional information
about a broker-dealer's custodial activities and to make it easier for
examiners to identify risks and possible violations of laws and
regulations concerning the broker-dealer's custody of assets.\542\ If,
upon reviewing Form Custody, regulatory authorities were to become
aware of inconsistencies or other red flags in information contained on
the form, they could initiate a more focused and detailed analysis of
the broker-dealer's custodial activities. Such an analysis could, in
turn, identify potential abuses related to customer assets. Moreover,
proposed Form Custody was intended to expedite the examination of a
broker-dealer's custodial activities and reduce examination costs, as
examiners would no longer need to request basic custody-related
information already disclosed on the form.\543\
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\541\ See Form X-17A-5 Schedule I, Part II, Part IIa, Part IIb,
and Part III.
\542\ See Broker-Dealer Reports, 76 FR at 37585.
\543\ Id.
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The Commission proposed that a broker-dealer file Form Custody with
its DEA within 17 business days after the end of each calendar quarter
and within 17 business days after the date selected for the broker-
dealer's annual report where that date was other than the end of a
calendar quarter.\544\ The Commission received one comment regarding
proposed paragraph (a)(5) of Rule 17a-5, which supported the
Commission's proposal as to when a broker-dealer should be required to
file Form Custody.\545\
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\544\ Id. at 37592.
\545\ See Shatto Letter.
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The Commission is adopting paragraph (a)(5) of Rule 17a-5
substantially as proposed. As to when a broker-dealer must file its
Form Custody with its DEA, the Commission is adopting its proposal that
a broker-dealer file Form Custody with its DEA within 17 business days
after the end of each calendar quarter.\546\ However, for year end
filings of Form Custody by a broker-dealer that has selected a fiscal
year end date that is not the end of a calendar year, the Commission
has modified its proposal to provide that a broker-dealer also must
file Form Custody with its DEA within 17 business days after the end of
the broker-dealer's fiscal year.\547\
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\546\ See paragraph (a)(5) of Rule 17a-5.
\547\ Id. Consistent with the proposal, a broker-dealer must
file Form Custody with its DEA at the same time that the broker-
dealer files its FOCUS Report with its DEA. However, s 
