Proposed Temporary Rule for an Interim Program of Inspection Related to Audits of Brokers and Dealers

One of the Board's major tasks next year will be implementation of the Board's new responsibilities for auditors of broker-dealers. Section 982 of the Dodd-Frank Wall Street Reform and Consumer Protection Act gave the Board inspections, standard-setting, and enforcement authority over auditors of all SEC-registered securities brokers and dealers. Since the end of 2008, those auditors have been required to register with the Board, but have not otherwise been subject to PCAOB authority. The temporary interim inspection rule the Board is considering today is the first step down the road of turning that new authority into a functioning oversight program.

These new responsibilities will have a significant effect on our work. There are about 5,000 broker-dealers. In the past two years, over 500 accounting firms have registered with the Board because they audit broker-dealers. In addition, many previously-registered firms that audit issuers also have broker-dealer practices. While there are a handful of mega firms, most broker-dealers are very small. Less than one percent — 33 firms — have net capital in excess of $1 billion. Those 33 firms hold over 80 percent of the net capital in the entire broker-dealer industry. At the other end of the spectrum, 70 percent of all broker-dealers have tentative net capital under $1 million. Collectively, those firms have less than one percent of industry net capital.

As to activities, the pattern is similar. About 520 brokerage firms provide clearing or custodial services. Many of the others are introducing firms that, at least in theory, do not have access to client funds or securities. Some are floor brokers without public clients; some are insurance agents that sell products that are technically securities; some are finders active in the M&A market; some are captives that serve the trading needs of a single, affiliated client. Other categories undoubtedly exist. This diversity raises questions about whether we should devote resources to inspecting the auditors of all of these types of brokers and dealers or whether some of their auditors can safely be exempted from PCAOB oversight without compromising investor protection.

While the Board does not yet have the answers to those questions, the temporary rule will allow the Board to begin inspections of broker-dealer audits so that we can develop an empirical basis on which to eventually address them. The interim inspections will focus both on reviewing the work performed on specific audits and on gathering facts to inform the Board's consideration of a permanent program. The information-gathering aspect of the interim inspections will provide the Board with insight about the potential benefits of broker-dealer inspections to the investing public and about the potential costs and regulatory burdens that would be imposed on different categories of accounting firms and classes of brokers. Armed with this type of information, the Board will be in a better position to decide on possible exemptions from oversight and to determine the objectives, nature, and frequency of inspections for firms that remain subject to PCAOB jurisdiction.

Decisions about the permanent inspection program are probably at least a year away. In the mean-time, there will be ample opportunity for the public to learn what the Board is finding in the interim program and to participate in the decision process. The proposed temporary rule provides for transparency, in that the Board will issue public reports at least annually on the progress of the interim program and on any significant observations. The permanent broker-dealer auditor inspection program will be predicated on rules that will only be adopted by the Board after public notice-and-comment and will only take effect after Securities and Exchange Commission approval.

The Board will also issue firm-specific reports on the inspections performed in the interim program, just as it does under the existing public company auditor inspection program. However, the release accompanying the proposed rule envisions that firm-specific reports will not be finalized until the firms in question have had an inspection in the permanent program. Nonetheless, the interim program will include identifying and promptly addressing with the inspected firm any significant audit issues the Board uncovers. That may include taking disciplinary action, if appropriate. In addition, the Board will refer information about potential broker-dealer violations to the Commission and to the Financial Industry Regulatory Authority.

*   *   *

While the interim broker-dealer auditor inspection program will be carried out by the inspections staff, this rule-making has largely been the responsibility of the Office the General Counsel, under the dedicated leadership of the Board's General Counsel, Gordon Seymour. I want particularly to thank Michael Stevenson, Deputy General Counsel, and Bob Burns, Associate General Counsel, for the work, and more importantly the thought, that has gone into the proposed temporary rule.

Related Information