On June 15, 2011, the SEC proposed three sets of changes to Rule 17a-5 of the Securities Exchange Act of 1934. The first set of amendments would replace the practice of auditing broker dealers called the Study. The Study was removed from CPA auditing procedures several years ago. The Public Company Accounting Oversight Board would establish new auditing standards, and inspect CPAs of broker dealers, as required by the Dodd-Frank Act.
The second set of amendments would require custody broker dealers, subject to the requirements of Rule 15c3-3, to file with the SEC the new “Compliance Report” asserting compliance with specified rules and related internal controls, and the new “Examination Report” from their CPAs addressing the assertions in the Compliance Report. Non-Custody broker dealers exempt from Rule 15c3-3 would file the new “Exemption Report,” and a CPA report addressing their exemption. In addition, clearing broker dealers must provide consent for their CPAs to provide audit documentation and discuss with the SEC any findings related to the audit reports.
The Compliance Report would include a statement as to whether the custody broker dealer has implemented and maintained an internal control system to provide reasonable assurance that any instances of material non-compliance with Rule 15c-1; Rule15c3-3; Rule 17a-13; and the rules prescribed by the designated examining authorities requiring broker dealers to send account statements to customers, (collectively the “Financial Responsibility Rules”), will be prevented or detected on a timely basis. In addition, their CPAs would be required to immediately report to the SEC any instance of material non-compliance with the Financial Responsibility Rules found during their examinations. Dual registered investment advisers and broker dealers where the broker dealer has custody of adviser client funds can use the Examination Report to satisfy the internal control reporting requirements of the Investment Adviser Custody Rule.
The third set establishes the “Form Custody” report, which would be filed quarterly with the Focus Report. The Form Custody report will contain nine (9) disclosure Items as
follows: 1) replaces the introducing broker dealer with the term “fully-disclosed broker dealer” in order to identify dual carrying arrangements. For example, a broker
dealer can be an introducing broker dealer for equities, and custody broker for
options. 2) discloses if the broker dealer introduces customer accounts to another broker dealer on an omnibus basis. A broker dealer that introduces these accounts is considered a custody person under the Financial Responsibility Rules. 3) this Item has five subparts to complete. The first two parts list the broker dealer customers and non-customers. The next part lists the locations of the held securities and funds. The last two parts list the types and amounts of custody and free credit balances, for customers and non-customers. Including how the broker dealer treats free credit balances in accordance with Rule 15c3-3. 4) discloses if the broker dealer acts as carrying broker for other broker dealers, and if any brokers are affiliated. Also, list those client securities and funds held on a fully disclosed or omnibus basis. 5) discloses if the broker dealers send trade confirmations directly to customers or through a third party. 6) list any carrying agreements where the introducing broker designates the responsibility of sending customer account statements to the clearing broker. 7) discloses if custody customers have electronic access to their securities and cash positions information. 8) ask if the broker dealer operates as an investment adviser. If yes, detailed information is requested about the adviser’s authority over the customer accounts; whether the customer assets are recorded on the adviser or the broker dealer systems; if the custodian sends account statements directly to clients; and other information about the broker dealer’s function as an investment adviser. 9) discloses if broker dealer is affiliated with an investment adviser, and if it has custody of client assets. For this purpose, an affiliate is any person who directly or indirectly controls the broker dealer, or under common control with the broker dealer. Ownership of 25% or more of the common stock of the investment adviser is considered control.
Also, the SEC proposed to change Annual Reports submitted by broker dealers. The broker dealer must stamp “confidential” on each page of the annual report that it wants confidential. Currently, a statement denoting confidentiality on the annual report section cover page is used.