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

Section 982 of the Dodd-Frank Wall Street Reform and Consumer Protection Act gave the Board inspection, standard-setting, and enforcement authority over auditors of all SEC-registered securities brokers and dealers. The temporary interim inspection rule the Board is considering today is a major step on the road of turning this new authority into a functioning oversight program.

While getting interim inspections up and running is important, many questions will still need to be addressed. One of the most critical is whether or not the permanent program should apply to all brokerage firm audits. There are about 5,000 broker-dealers. However, only 520 or so 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 in business models and risk profiles raises obvious questions about whether the Board should devote resources to inspecting the auditors of all of these types of brokers and dealers or whether some can safely be excluded without compromising investor protection.

In enacting Section 982, Congress heard arguments in favor of exempting some classes of audits, such as non-custodial introducing firms, which do not seem to pose much risk to the general investing public. However, both the SEC and SIPC staffs recommended against exemptions, and the Act contains none. Instead, Section 982 turns the problems of differential oversight and exemptions over to the Board. The statute directs the Board to consider "whether differing [inspection] schedules would be appropriate with respect to registered public accounting firms that issue audit reports only for * * * brokers or dealers that do not receive, handle, or hold customer securities or cash or are not a member of the Securities Investor Protection Corporation." The law is silent on how the Board should make these decisions. If the Board does decide that auditors of some types of broker-dealers need not be subject to any inspection schedule at all, those firms may withdraw from registration.

Because of the lower risk of investor harm, I believe that the Board will ultimately conclude that auditors of some classes of brokerage firms should be exempt from PCAOB oversight. I also believe, however, that the best way to make that decision is on the basis of the type of factual information that can most effectively be collected during the interim inspection program.

The temporary rule will allow the Board to develop an empirical record on whether to adopt differing inspection schedules or exemptions for some classes of firms. In fact, the primary focus of the interim inspections will be on gathering data to inform Board consideration of how to structure a permanent inspection program, including potential benefits to the investing public and potential costs and regulatory burdens. Armed with this information, the Board will be in a better position to determine the objectives, nature, and frequency of inspections for different classes of firms; to decide on possible exemptions from oversight; and to defend those determinations and decisions, if they are questioned.

Some commenters have argued that broker-dealer audit costs are rising and that this imposes burdens on smaller introducing firms which should be addressed immediately. It is important to recognize, however, that the Board has not yet taken any action at all to change the way broker-dealer audits are conducted. Increases in audit effort and fees are likely the result of the attention that brokerage firm auditing has attracted in the wake of the Madoff Ponzi scheme and of the criminal proceeding against Madoff's auditor. In any case, only a small number of firms whose audit work is limited to non-custodial introducing broker-dealers are likely to be inspected during the interim program.

The temporary rule provides for transparency concerning what the Board is finding in interim inspections, and there will be ample opportunity for everyone affected to weigh in on whether some firms should be excluded from the permanent program. The Board will issue public reports at least annually on the progress of the interim program and on any significant observations. The Board will also eventually issue firm-specific reports, but those will not be finalized unless and until a firm has also had an inspection in the permanent program.

Overall, the interim rule approach strikes the right balance between the Board's obligation to develop the information necessary to design an inspection program that fulfils its investor protection responsibilities and the legitimate concerns regarding the need to avoid imposing unnecessary costs on small brokerage firms and their auditors. I support the rule.

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This rule-making has largely been the responsibility of the Office the General Counsel, lead by the Board's General Counsel, Gordon Seymour. I want particularly to thank Deputy General Counsel Michael Stevenson, and Assistant General Counsel Jennifer Williams, for their work. The broker-dealer auditor interim inspection program will be headed by Bob Maday, Associate Director in the Division of Registration and Inspections. I also want to recognize the contributions that Bob and his colleagues in the Division have made to this project. Their work is just beginning.

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