Proposed Standards for Attestation Engagements Related to Broker and Dealer Compliance or Exemption Reports

Last Summer, in the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress assigned to the Board oversight responsibility for the audits of SEC-registered broker-dealers. At the Board's June 14 meeting, we adopted rules to put in place two parts of the foundation for that new oversight program — funding and interim inspections. Today, the Board begins consideration of the third piece of that foundation — the standards by which broker-dealer auditors do the work that the SEC's broker-dealer reporting rules require of them.

The auditing and attestation standards before the Board would establish rules-of-the-road for auditor association with reports that the SEC has proposed to require broker-dealers to file with the Commission concerning compliance with the Commission's financial responsibility requirements, including the net capital and customer protection rules. Unlike public company auditing, the protection that investors derive from the auditor's broker-dealer work results primarily from the auditor's association with compliance-related information outside the financial statements. The examination and review engagements that are the basis for auditor reporting on these matters provide the Commission, FINRA, and investors with independent assurance that customer assets are not improperly exposed to misappropriation or similar risks.

The Board's proposed standards dovetail with the Commission's proposed amendments, published last month, to Securities Exchange Act Rule 17a-5. Specially --

• Under revised Rule 17a-5, broker-dealers that have custody of customer assets would file with the Commission a report indicating that the firm is in compliance with the net capital and customer protection rules and that its controls over customer assets are operating effectively. The SEC proposals require that a PCAOB-registered auditor examine and attest to these reports.
• Broker-dealers that do not have custody of customer assets would file a report demonstrating that they are exempt. These firms would file a review report prepared by their auditor regarding the asserted exemption.

In addition to the new compliance or exemption reports, broker-dealers already file certain supplemental information, along with their financial statements, showing the calculation of their net capital and reserve requirements and information related to possession and control of customer assets. The firm's auditor is required to review and report on this supplemental information.

The proposed standards that would govern these tasks are designed to provide the level of assurance the SEC requires, but without generating unnecessary expense or complexity, especially for smaller firms. The broker-dealer community is very diverse, and the business models and risk profiles of the roughly 5,000 registered broker-dealer firms vary. The proposals recognize that reality. They are explicitly risk-based and are intended to be scalable to firms of different types and sizes. The standards also emphasize that the financial statement audit and the work related to financial responsibility compliance should be coordinated to avoid needless duplication of effort. Most brokers are introducing firms that do not hold customer assets and, consistent with the SEC's expectations, the auditor's review of an exemption report would not require the auditor to marshal the same level of evidence as in an examination of a clearing firm's compliance report.

Still, as the Board knows from experience, striking the right balance in this kind of audit area is tricky. I hope that, in their comments, investors, brokerage firms, and auditors will focus on whether there are ways we can improve these standards before they are finally adopted to make sure that, for small broker-dealers in particular, they will work both effectively and efficiently.

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The drafting of these standards, including the underlying legal and auditing analysis, has been a major undertaking. I want to particularly acknowledge the contributions of Keith Wilson, Barb Vanich, Nick Grillo, Lisa Calandriello, Michael Gurbutt, and Hong Zhao in the Office of the Chief Auditor, and Bob Burns and Nina Mojiri-Azad in the Office of the General Counsel.