Changes to Broker-Dealer
Reporting & Auditing Requirements
Reporting and auditing requirements for broker-dealers changed significantly starting June 1, 2014. These changes
are the culmination of several years of outreach and debate to enhance customer protection following the 2007
financial crisis and several high-profile broker-dealer collapses.
Background
The Sarbanes-Oxley Act of 2002 (SOX) created the Public Company Accounting Oversight Board (PCAOB) and
required that auditors of U.S. public companies be subject to external, independent oversight for the first time. In
2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act amended SOX to give the PCAOB oversight
of the audits of broker-dealers registered with the SEC. In July 2013, the Securities and Exchange Commission
(SEC) finalized amendments to Rule 17a-5 on annual reporting, audit and notification requirements for brokerdealers. The rules required that broker-dealer audits and reviews of newly required compliance and exemption
reports be conducted by firms registered with the PCAOB in accordance with PCAOB standards. The SEC rules
were effective as of June 1, 2014.
To address the SEC’s amendments, PCAOB adopted three auditing and attestation standards to establish guidance
for the auditor’s responsibility related to the new reports. The attestation standards will apply to all registered
accounting firms conducting attestation engagements related to broker-dealer compliance or exemption reports.
The standards do not extend to the audit work performed in connection with the client asset custody
arrangements of registered investment advisors, which are governed by other SEC rules. These PCAOB rules are
effective for fiscal years ending on or after June 1, 2014.
Recent Updates
On May 2, 2014, the SEC approved on an accelerated basis the PCAOB’s proposed broker-dealer rules, bringing
those rules into conformance with Dodd-Frank amendments. The amendments modify the PCAOB’s professional
practice standards to include the audits of brokers and dealers to the same extent they previously applied to the
audits of financial reporting issuers, along with several technical updates. PCAOB’s registration, withdrawal and
reporting forms (Forms 1, 1-WD, 2, 3 and 4) have been updated to include relevant broker and dealer audit client
information. Other technical changes include:

Clarification on the definition of “person associated with a public accounting firm”

Allowing the PCAOB to share certain information with foreign auditor oversight authorities

Clarification that PCAOB’s sanctioning authority is not limited to persons who are supervisory personnel at
the time a failure-to-supervise sanction is imposed

An updated definition of “audit committee” to include brokers and dealers that may not have
organizational structures that include audit committees
As approved by the SEC, these amendments to the PCAOB’s rules and Ethics Code took effect June 1, 2014. The
amendments to Forms 1, 1-WD, 3 and 4 took effect on July 1, 2014. The amendments to Form 2, used to file the
annual report of a registered public accountant firm, will take effect April 1, 2015.
Recent updates to the Commodities Futures Trading Commission’s (CFTC) customer protection rules mean the
changes approved by the SEC are applicable to audits and attestation engagements of brokers-dealers and futures
commission merchants (FCM), including those that are dual-registered.
Changes to Broker-Dealer Reporting & Auditing Requirements
Compliance Report & PCAOB Attestation Standard No. 1
SEC’s amendments will require broker-dealers to report on their internal controls on compliance in certain areas,
including net capital requirements (Rule 15c3-1), customer protection, reserves and custody of securities (Rule
15c3-c), quarterly security counts (Rule 17a-13) and compliance with the entities’ designated enforcement agency
(DEA)* rules on customer statements. The SEC collectively refers to these rules as the “Financial Responsibility
Rules.”
Registered broker-dealers would be required to prepare a compliance report including a statement that the
broker-dealer has established and maintained a system of internal control to provide the broker-dealer with
reasonable assurance that any instance of noncompliance with net capital and reserve rules would be prevented
or detected on a timely basis. Broker-dealers will not be required to assess the effectiveness of internal controls
over financial reporting as issuers are required to do in connection with SOX.
PCAOB’s Attestation Standard No. 1, Examination Engagements Regarding Compliance Reports of Brokers and
Dealers, establishes the auditor’s requirements for examining the new SEC compliance reports and requires
auditors to obtain sufficient, appropriate evidence to provide reasonable assurance on the following statements in
the compliance report:

The broker-dealer was in compliance with the net capital rule and reserve requirement rule at fiscal yearend

The broker-dealer had effective internal control over compliance (ICOC) during the year and at year-end

The broker-dealer based its assertions on information from its books and records
* A broker-dealer that is a member of more than one securities self-regulatory organization may be assigned a
DEA that is responsible for examining the broker-dealer’s compliance with SEC financial responsibility rules.
Example of DEAs include the National Association of Securities Dealers (NASD), Chicago Board Options Exchange
(CBOE) and Financial Industry Regulatory Authority (FINRA).
The rules covered by ICOC are broader than those covered by the compliance statement.
ICOC - entire year and
at year-end
• 15c3-1, 15c3-c, 17a-13
• Account Statement Rule
Compliance
Statement year-end only
•15c3-1
•15c3-3(e)
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Changes to Broker-Dealer Reporting & Auditing Requirements
Exemption Report & PCAOB Attestation Standard No. 2
Many brokers are introducing firms that do not hold customer assets. Some clearing broker-dealers clear only
their own transactions and do not hold customer securities or cash. If broker-dealers meet certain criteria, they
could be exempt from SEC’s Rule 15c3-3, Customer Protection – Reserves and Custody of Securities. Such brokerdealers would file an exemption report that would be reviewed by a PCAOB-registered independent public
accountant.
PCAOB’s Attestation Standard No. 2, Review Engagements Regarding Exemption Reports of Brokers and Dealers,
requires auditors to obtain moderate assurance whether conditions exist that would cause one or more of the
following assertions not to be fairly stated:

The provision under which the broker-dealer claimed an exemption

A statement that the broker-dealer either
•
•
Met the identified exemption provisions throughout the most recent fiscal year without
exception
Met the identified exemption provisions throughout the most recent fiscal year, with some
exception(s); a broker-dealer would need to identify each exception with a brief explanation and
the date(s) when the exception(s) existed
SIPC
The Securities Investor Protection Corporation (SIPC) is a not-for-profit corporation responsible for providing
financial protection to customers of failed broker-dealers. The SEC previously only required limited information to
be filed with SIPC. SEC’s amendments require SIPC-member broker-dealers to file their full annual reports with
SIPC—including the independent registered public accountant’s reports covering the financial statements and the
compliance or exemption report. This requirement was effective December 31, 2013.
Form Custody
All broker-dealers are required to file with their DEA a new quarterly report called Form Custody, which contains
information on how custody is maintained on customer assets and relationships with other custodians. The report
is to be filed within 17 days after the end of each calendar quarter and should be based on settlement date
positions. All securities carried by a broker-dealer should be included in the Form Custody report including fully
paid, margin and excess margin securities. Only futures collateral held in a securities account should be included in
the report. Market value ranges of securities held for customers and noncustomers should be determined based
on aggregate long positions only. Unpriced positions and fails related to delivery versus payment or receive versus
payment transactions should be excluded from market value.
Notification Requirements
An auditor must immediately notify the broker-dealer’s chief financial officer of any instances of noncompliance
with the financial responsibility rules and the nature of the noncompliance or existence of a material weakness.
When the broker-dealer is required to notify the SEC, a copy also must be provided to the auditor. If the auditor
does not receive the notice within one business day or disagrees with the notice, it must notify the SEC.
PCAOB Auditing Standard No. 17: Supplemental Information
Broker-dealers also file with their financial statements certain supplemental information, including the calculation
of their net capital and reserve requirements and information related to possession and control of customer
assets. This standard sets forth the independent accountant’s responsibilities when the auditor of the financial
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Changes to Broker-Dealer Reporting & Auditing Requirements
statements is engaged to perform audit procedures and report on whether supplemental information
accompanying the financial statements is fairly stated, in all material respects, in relation to the financial
statements as a whole. An auditor is required to perform the following procedures:

Determine the supplemental information reconciles with the underlying accounting and other records or
the financial statements, as applicable

Test the completeness and accuracy of the supplemental information, to the extent it was not tested as
part of the audit of the financial statements

Evaluate whether the supplemental information, including its form and content, complies with relevant
regulatory requirements or other applicable criteria
SEC’s amendments to Rule 15c3-3 require broker-dealers carrying proprietary accounts of broker-dealers (PAB)
to perform a separate reserve computation for PAB accounts and a supplemental schedule containing the PAB
calculation will have to be included in the financial report. For audits of broker-dealers with fiscal years ending
on or after June 1, 2014, this required supplemental schedule will be required to be audited in accordance with
AS 17.
Futures Commission Merchants
Some broker-dealers are registered with both the SEC as a broker-dealer and with the CFTC as an FCM. Previously,
the PCAOB had no jurisdiction over FCMs registered with the CFTC. The SEC and CFTC have aligned the reporting
and auditing requirements for dual-registered broker-dealers with CFTC’s release, Enhancing Protections Afforded
Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations.
On March 28, 2014, the CFTC issued Letter No. 14-40, Interpretation of Commission Regulation 1.16 Auditor
Independence Standards for Audits of Futures Commission Merchants, which provides clarification over FCM
auditor independence requirements. In combination, these CFTC releases will affect audits of FCMs and those
dually registered as FCMs and broker-dealers for fiscal years ending on or after June 1, 2014, as noted below:

FCM auditors must be registered with the PCAOB

FCM audits must comply with the PCAOB standard; currently, such audits are conducted in accordance
with AICPA standards

FCM auditors must have undergone an inspection by the PCAOB by December 31, 2015

FCMs and their auditors would be deemed to be in compliance with CFTC Regulation 1.16(c)(2) if they
comply with the auditor independence requirements of SEC Rule 17a-5
FCM auditors still must issue a Report of Internal Control disclosing any material inadequacies (MI) existing at the
date of the audit. The SEC amendments to Rule 17a-5 replace the requirement for the MI letter to be issued by
auditors of broker-dealers. However, this requirement currently remains in place for audits of FCMs (including
those dually registered as FCMs and broker-dealers) subject to CFTC regulation. Auditors of dual-registered FCMs
and broker-dealers will be required to issue both an MI letter and either an examination or review report, in
accordance with Rule 17a-5.
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Changes to Broker-Dealer Reporting & Auditing Requirements
Reporting Requirements & Audit Assurance
Dual Registration
CFTC – FCM Only
Material Inadequacy Letter – The scope of the audit
and review of the accounting system, the internal
control and procedures for safeguarding securities
shall be sufficient to provide reasonable assurance
that any material inadequacies existing at the date of
examination in accounting systems, internal
accounting control or procedures for safeguarding
securities would be disclosed.
SEC-Registered Broker-Dealers Only

Compliance Report – “The broker-dealer has
established and maintained a system of internal
control to provide reasonable assurance that any
instance of noncompliance with net capital and
reserve rules would be prevented or detected on
a timely basis.”
OR

Exemption Report – “Based on our review we
are not aware of any material modifications that
should be made to management’s statements for
them to be fairly stated in all material aspects.” –
moderate assurance
Additional Resources
The SEC has issued two Frequently Asked Questions (FAQ) documents to address various implementation matters:
FAQs Concerning the Amendments to Certain Broker-Dealer Financial Responsibility Rules
FAQs Concerning the July 30, 2013 Amendments to the Broker-Dealer Financial Reporting Rule
To learn more about how these new requirements could affect your organization, contact your BKD advisor.
Contributor
Anne Coughlan
Director
317.383.4000
acoughlan@bkd.com
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