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Broker-Dealer Update

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Learning Center

Learning Objectives

After completing this course, you should be able to:

• Understand the Securities and Exchange Commission (SEC)

amendments to Rules 17a-5 and 17a-11 under the Securities

and Exchange Act of 1934 issued in July 2013.

• Understand the PCAOB standards for broker-dealer audits and

auditing supplemental information.

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Continuing Professional Education

There will be random attendance pop-up markers during the event

To obtain CPE, you must click “OK” on 75% of the participation pop-up markers

If you are not receiving CPE for this event, ignore the pop-up markers

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Learning Center

Chris Donovan, Deloitte & Touche LLP

Paul Nockels, McGladrey LLP

Irina Portnoy, AICPA (moderator)

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Presenters

Learning Center

Agenda

Broker-Dealer Reports

• The Compliance Report

• The Exemption Report

Filing Annual Reports

Notification of Non-Compliance or Material Weaknesses

Access to Accountant and Audit Documentation

Form Custody

Independent Public Accountant’s Responsibility

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Broker-Dealer Reports

Learning Center

Overview

What the reports are designed to do:

• Give the SEC, FINRA and SIPC more detail about a broker-dealer’s

handling of customer funds and securities

• SEC stated that it represents “a first stop 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.”

Why:

• Madoff

• Other Ponzi schemes

• Sloppy recordkeeping/weak internal controls for safeguarding investor

assets

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Learning Center

New Reports

Compliance Report

• Carrying firms

• Clearing firms

Exemption Report

• (k)(1) – Limited business (mutual funds and/or variable annuities

only)

• (k)(2)(i) – Special account for the exclusive benefit of customers

• (k)(2)(ii) – Customer transactions are cleared through another

broker-dealer on a fully disclosed basis

• (k)(3) – special exemption by the SEC

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Learning Center

Compliance Report

Applies to:

• Broker-dealers that do not claim an exemption from SEC Rule

15c3-3 (the Customer Protection Rule) throughout the most

recent fiscal year

Filed with:

• The broker-dealer’s annual audited financial report

Provided to

• SEC, FINRA or DEA

• SIPC, if the broker-dealer is a SIPC member

Effective date:

• For fiscal years ending on or after June 1, 2014

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Learning Center

Compliance Report - Statements

The Compliance Report includes five (5) specific statements

1. The broker-dealer has established and maintained Internal Control Over Compliance

2. Internal Control Over Compliance was effective as of the during the fiscal year

3. Internal Control Over Compliance was effective as of the end of the fiscal year

4. Broker-dealer was in compliance with Rule 15c3-1 (the Net Capital Rule) and Rule 15c3-3(e) (the Customer Reserve Requirement of the Customer Protection Rule) as of the end of the fiscal year

5. The information in #4 was derived from the books and records of the broker-dealer

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Learning Center

Compliance Report – Descriptions

The Compliance Report also includes two (2)

descriptions, if applicable

1) Each identified material weakness in the Internal Control Over

Compliance during and as of the end of the fiscal year

2) Any instances of non-compliance with the Net Capital and the

Customer Reserve Requirement of the Customer Protection

Rules as of the end of the fiscal year

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Learning Center

Compliance Report – Definitions

Internal Control Over Compliance

• 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

Material Weakness

• A deficiency, or a combination of deficiencies, in the broker-dealer’s Internal Control Over Compliance such

- that there is a reasonable possibility that non-compliance with the Net Capital and the Customer Reserve Requirement of the Customer Protection Rules 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), or any Account Statement Rule will not be prevented or detected on a timely basis

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Learning Center

Compliance Report – Changes from

Proposed Rules

The final rules reflect two (2) changes from the

proposal:

1) Elimination of the concept of material non-compliance and

compliance in all material respects

2) A narrowing of these statements and requirements from

compliance with all of the financial responsibility rules to

compliance the Net Capital and the Customer Reserve

Requirement of the Customer Protection Rules

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Learning Center

Exemption Report

The Exemption Report includes three (3) statements

made to the “best knowledge and belief” of the

broker-dealer

1) Identified the exemption claimed under Rule 15c3-3(k)

2) Met the identified exemption provision of Rule 15c3-3(k) during

the fiscal year without exception or exceptions are described in

the Exemption Report

3) If applicable, identification of exception during the fiscal year

(include nature and approximate date(s))

The Exemption Report must cover the most recent

fiscal year

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Filing Annual Reports

Learning Center

Filing Annual Reports

Amended Rule 17a-5(d)(5) to replace the term

“annual audit report” with “annual reports”

Annual reports include

1) Financial report

2) Compliance or Exemption report

3) Reports prepared by an independent public accountant

covering 1 and 2

Time for filing annual reports: 60 calendar days

after the fiscal year end

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Learning Center

Who Gets Annual Reports?

Current requirement: Annual Audited Reports are

filed with

• SEC HQ

• SEC Regional office

• FINRA/DEA

• SROs of which the broker-dealer is a member

New requirement: Annual Reports are filed with • SIPC, if the broker-dealer is a member

• No longer required to file with SROs that are not the broker-dealer’s

DEA, if the SRO waives the requirement

Effective Date: December 31, 2013

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Learning Center

Filing Annual Reports with SIPC

Broker-dealers must also file their annual reports

with SIPC

Inclusion of the annual reports is intended to assist

SIPC in monitoring the financial strength of broker-

dealers and assessing the adequacy of the SIPC

fund

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Notification

Learning Center

Notification of Non-Compliance or Material

Weakness

The notification provisions for broker-dealers (Rule 17a-11) have not changed • Replaced “material inadequacies” with “material weakness”

Broker-dealer must provide a copy of the notification to the accountant within one business day

If the accountant does not receive or agree with the statements in the notice, the accountant must provide a report to the Commission and DEA on the aspects of the notification of the broker-dealer with which the accountant does not agree within one business day

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 accountant must immediately notify the broker-dealer’s CFO of the nature of the material weakness

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Access to Accountant and

Audit Documentation

Learning Center

Access to Accountant and Audit

Documentation

SEC amended Rule 17a-5 to require that each clearing broker-dealer agrees to allow SEC and its DEA examination staff

• to review the audit documentation associated with its annual audit reports

• allow its independent public accountant to discuss findings relating to the audit reports with the SEC and DEA

Access to information and discussions with a clearing broker-dealer’s independent public accountant would enhance the efficiency and effectiveness of Commission and DEA examinations

This requirement is limited to clearing broker-dealers, which generally have more complex business operations than non-carrying firms

Request to a broker-dealer’s independent public accountant for the accountant to discuss audit findings or for access to audit documentation must be made in writing

SEC anticipates that it will accord confidential treatment to such documents to the extent permitted by law

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Form Custody

Learning Center

Form Custody

Effective Date: December 31, 2013

All broker-dealers must file this form with their DEAs within 17 business days after the end of each calendar quarter (even if a broker-dealer has no customer or non-customer accounts)

Goal – designed to elicit information concerning whether a broker-dealer maintains custody of customer/non-customer assets and, if so, how

Questions on the form that can’t be answered because the broker-dealer does not engage in a particular activity can be ignored

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Learning Center

Form Custody –

There are nine (9) items designed to elicit

information about a broker-dealer’s custodial

activities:

1. Accounts Introduced on a Fully Disclosed Basis

2. Accounts Introduced on a Omnibus Basis

3. Carrying Broker-Dealers

4. Carrying for Other Broker-Dealers

5. Trade Confirmations

6. Account Statements

7. Electronic Access to Account Information

8. Broker-Dealers Registered as Investment Advisers

9. Broker-Dealers Affiliated with Investment Advisers

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Independent Public

Accountant’s

Responsibility

Learning Center

Independence

Follow SEC independence rules (Regulation S-X)

• Auditors cannot provide

- Bookkeeping or other services related to accounting records or financial statements preparation

- Financial information systems design and implementation

- Management functions or human resources

• Certain Regulation S-X rules do not apply

- Partner rotation

- Audit committee pre-approval

• Review of the exemption report or perform an examination of the compliance report

- The exemption and compliance reports MUST BE prepared by the broker-dealer

PCAOB independence rules pending (stay tuned)

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Learning Center

Engagement of the Accountant

Current Requirements, applicable to audits of year ends

through May 31, 2014

• Audits of broker dealers reports filed with SEC made in accordance

with generally accepted auditing standards (GAAS)

• Report on Internal Control Report prepared by the accountant

New Rules, applicable to audits of year ends on and after

June 1, 2014

• Audits and attestation of broker dealers reports filed with SEC will be

made in accordance with PCAOB standards

• Auditor’s Report on Internal Control previously required by SEC Rule

17a-5(g)(1) is replaced by the auditor’s Examination Report or Review

Report, as appropriate

• The PCAOB is working to finalize the permanent inspection program of

audits of broker-dealers. The interim inspection program is anticipated

to continue through 2014.

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Learning Center

PCAOB Standards

SEC amended Rule 17a-5 to state that examination of

Compliance Reports and review of Exemption Reports will be

in accordance with PCAOB Standards

PCAOB in 2011:

• Proposed Auditing Standard on Auditing Supplemental Information

Accompanying Audited Financial Statements and Related Amendments

to PCAOB Standards

• Proposed Standards for Attestation Engagements Related to Broker

and Dealer Compliance or Exemption Reports

These standards are to align attestation standards more

closely with the auditor’s responsibility under the amendments

to Rule 17a-5

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Learning Center

PCAOB Standards (continued)

On October 10, 2013, the PCAOB adopted the Attestation

Standards and Auditing Standard No. 17, Auditing

Supplemental Information Accompanying Audited Financial

Statements

• Effective for fiscal years ending on or after June 1, 2014 (subject to

SEC approval)

PCAOB also proposed an update to certain rules to conform to

the Dodd-Frank amendments to the Sarbanes-Oxley Act, which

includes

• Rules requiring that registered firms comply with the PCAOB standards

• Ethics and independence requirements

• These are pending final approval

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Learning Center

PCAOB – Attestation Standards

Two attestation standards that cover the auditor’s

examination regarding compliance reports and the

auditor’s review regarding exemption reports of

broker-dealers were adopted

• Examination Standard: Attestation Standard No. 1,

Examination Engagements Regarding Compliance Reports of

Brokers and Dealers

• Review Standard: Attestation Standard No. 2, Review

Engagements Regarding Exemption Reports of Brokers and

Dealers

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Learning Center

PCAOB – Examination Standard

Provides requirements for the auditor that include

the following:

• Obtaining sufficient appropriate evidence to opine on the

Compliance Report

• Focusing on matters that are most important to the auditor’s

conclusion regarding the statements of the broker-dealer

• Consideration of fraud risk, including the risk of misappropriation

of customer assets

• Coordination of the examination engagement with the audit of

the financial statements and audit procedures performed on

supplemental information

• Description of how to report on an examination engagement, in

connection with the requirements of SEC Rule 17a-5

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Learning Center

PCAOB – Review Standard

Requires the auditor to obtain moderate assurance

about the following statements in the exemption

report:

• A statement that identifies the exemptive provisions claimed by

the broker-dealer

• A statement that the broker-dealer

1) Met the identified exemption provisions throughout the

fiscal year without exception OR

2) Met the identified exemption provisions throughout the

fiscal year, except as described in exemption report

3) If applicable, identification of each exception with

descriptions (nature and approximate date(s))

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Learning Center

PCAOB – Supplemental Information

Auditing Standard No. 17, Auditing Supplemental

Information Accompanying Auditing Financial

Statements

• A new standard

• Establishes the auditor's responsibilities when performing audit

procedures and reporting on supplemental information that

accompanies the audited financial statements of broker-dealers

and others

• Intended to give the SEC and other users greater confidence in

the quality and consistency of supplemental information

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Learning Center

PCAOB – Supplemental Information

(continued)

Requirement of the auditor:

• To determine that the supplemental information reconciles to the

underlying accounting and other records or to the financial

statements

• To test the completeness and accuracy of the supplemental

information

• To evaluate whether or not the supplemental information,

including form and content, complies with the relevant regulatory

requirements

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Learning Center

PCAOB – Supplemental Information

(continued)

Supplemental Information means:

• Supporting schedules required to be filed pursuant to Rule 17a-5

• Supplemental information

- Required to be presented pursuant to the rules and regulations of a regulatory authority

- Covered by an auditor’s report on that information related to financial statements that are audited in accordance with PCAOB standards

• Information that is

- Ancillary to the audited financial statements;

- Derived from the company’s accounting books and records; and

- Covered by an auditor’s report on that information related to financial statements that are audited in accordance with PCAOB standards

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Available in eBook, online, and print formats:

Brokers and Dealers in Securities Audit and Accounting Guide

Financial Institutions Industry Developments: Including

Depository and Lending Institutions and Brokers and Dealers in

Securities Audit Risk Alert

Brokers and Dealers in

Securities Guidance

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