United States

New reporting requirements for brokers and dealers

Require a new assessment and supporting documentation

INSIGHT ARTICLE  | 

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On July 30, 2013, the Securities and Exchange Commission (SEC) adopted amendments to SEC Rule 17a-5 that, among other things, require brokers and dealers to file either a new report on their compliance with  financial responsibility rules1 if they are subject to SEC Rule 15c3-3, or a new report indicating that they are exempt from SEC Rule 15c3-3. Brokers and dealers are also required to engage their auditors to perform either an examination of compliance with the financial responsibility rules, or a review of exemption from SEC Rule 15c3-3, under new attestation standards promulgated by the Public Company Accounting Oversight Board (PCAOB). These new requirements will apply for annual reports filed with the SEC for fiscal years ending on or after June 1, 2014. Management of brokers and dealers must perform an assessment to support issuance of either a compliance or exemption report. Management must also provide supporting documentation to enable their auditors to perform the required attestation engagement.

Compliance Report/Examination Engagement

New Requirements for Brokers and Dealers

The amended SEC Rule 17a-5 requires brokers and dealers not exempt from SEC Rule 15c3-3 to file a compliance report with its annually audited financial statements, which will contain the following statements:

  1. The Internal Control over Compliance of the broker and dealer was effective during the most recent fiscal year.
  2. The Internal Control over Compliance of the broker and dealer was effective as of the end of the most recent fiscal year.
  3. The broker and dealer was in compliance with SEC Rules 15c3-1 (net capital rule) and 15c3-3(e) (reserve requirement rule) as of the end of the most recent fiscal year.
  4. The information the broker and dealer used to state whether it was in compliance with the net capital rule, and the reserve requirements rule was derived from the books and records of the broker and dealer.

SEC Rule 17a-5 defines Internal Control over Compliance as internal controls that have the objective of providing the broker and dealer with reasonable assurance that noncompliance with the financial responsibility rules will be prevented or detected on a timely basis.

New Requirements for Auditors

Auditors of brokers and dealers will be required to perform an examination engagement of the broker’s and dealer’s compliance report pursuant to PCAOB Attestation Standard No. 1, Examination Engagements Regarding Compliance Reports of Brokers and Dealers. 

When performing the examination engagement, the auditor's objective is to obtain reasonable assurance about whether:

  1. One or more material weaknesses existed during the most recent fiscal year specified in the broker’s and dealer’s assertion.
  2. One or more material weaknesses existed as of the end of the most recent fiscal year specified in the broker’s and dealer’s assertion.
  3. One or more instances of noncompliance with the net capital rule or the reserve requirements rule existed as of the end of the most recent fiscal year specified in the broker’s and dealer’s assertion. 
  4. The assertion made by the broker and dealer that the information used to assert compliance with the net capital rule and the reserve requirements rule was derived from the books and records of the broker and dealer, is fairly stated, in all material respects.

SEC Rule 17a-5 defines material weakness as a deficiency, or a combination of deficiencies, in Internal Control over Compliance, such that there is a reasonable possibility that non-compliance with SEC Rules 15c3-1, 15c3-3(e) will not be prevented or detected on a timely basis, or that noncompliance to a material extent with SEC Rule 15c3-3, except for paragraph (e), SEC Rule 17a-13, or any rule of the designated examining authority of the entity that requires account statements to be sent to the customers of the entity will not be prevented or detected on a timely basis. 

Action Steps for Management of Brokers and Dealers

Management should implement the following steps for the June 1, 2014, effective date:

  • Ensure the existence of proper documentation of the broker’s and dealer’s internal controls supporting Internal Controls over Compliance.
  • Identify key controls related to Internal Controls over Compliance.
  • Perform appropriate testing to ensure that key controls related to Internal Controls over Compliance are operating effectively throughout the year. If any deficiencies are found, reassess the controls in place, remediate and consider the impact on reporting.
  • Ensure the regulatory calculations contained in the supplementary schedules are correct and supported by appropriate sections of the financial responsibility rules.
  • Ensure the supplementary schedule reconciles to the books and records.
  • Ensure procedures for preparation of the compliance report that complies with amended SEC Rule 17a-5.

Exemption Report/Review Engagement

New Requirements for Brokers and Dealers

The amended SEC Rule 17a-5 requires brokers and dealers exempt from SEC Rule 15c3-3 to file an exemption report with the annually audited financial statements, which will contain the following statements:

  1. A statement that identifies the provisions in paragraph (k) of SEC Rule 15c3-3, under which the broker and dealer claimed an exemption from.
  2. A statement that the broker and dealer: (1) met the identified exemption provisions throughout the most recent fiscal year without exception, or (2) met the identified exemption provisions throughout the most recent fiscal year, except as described in the exemption report
  3. If applicable, a statement that identifies each exception during the most recent fiscal year in meeting the identified exemption provisions, and that briefly describes the nature of each exception and the approximate date(s) on which the exception existed.

New Requirements for Auditors

Auditors of brokers and dealers will be required to perform a review of the broker’s and dealer’s exemption report prepared pursuant to PCAOB Attestation Standard No. 2, Review Engagements Regarding Exemption Reports of Brokers and Dealers.

When performing a review of the statements made by a broker and dealer in an exemption report, the auditor's objective is to state whether the auditor is aware of any material modifications that should be made to the entity's assertions. Conditions that would require material modifications include:

  1. The broker’s and dealer’s assertion that identifies the provisions in paragraph (k) of SEC Rule 15c3-3, under which the broker and dealer claimed an exemption is inaccurate.
  2. The broker and dealer asserts that it met the identified exemption provisions without exception when the auditor is aware of exceptions in meeting the exemption provisions.
  3. The broker’s and dealer’s assertion that identifies and describes each exception is inaccurate or incomplete.

Action Steps for Management of Brokers and Dealers

Management should implement the following steps for the June 1, 2014, effective date:

  • Ensure proper documentation of the broker’s and dealer’s internal controls supporting compliance with the exemption provisions of SEC Rule 15c3-3.
  • Identify key controls related to complying with exemption provisions of SEC Rule 15c3-3.
  • Perform appropriate testing to ensure key controls related to complying with exemption provisions of SEC Rule 15c3-3 are operating effectively, and to identify any exception from compliance with the exemption provisions.
  • Ensure the exemption provision claimed by the broker and dealer is correct.
  • Ensure proper controls for identifying and categorizing any exceptions from compliance with the exemption provisions.
  • If applicable, document the nature and time period of exception from compliance with the exemption provisions.
  • Ensure procedures for preparation of a review report that complies with amended SEC Rule 17a-5.

1 For purposes of this article, financial responsibility rules include: SEC Rules 15c3-3, 15c3-1, 17a-13 and any rule of the designated examining authority of the broker and dealer that requires account statements to be sent to customers.

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