A Small Entity Compliance Guide¹

Introduction

As described below, the Commission has amended certain reporting, audit, and notification requirements for broker-dealers registered with the Commission.  The Commission has also adopted amendments that require a broker-dealer that clears transactions or carries customer accounts to agree to allow representatives of the Commission or the broker-dealer’s designated examining authority (“DEA”) to review the documentation associated with certain reports of the broker-dealer’s independent public accountant and to allow the accountant to discuss its findings with the representatives if requested in writing for purposes of an examination of the broker-dealer.  Finally, the Commission has adopted a new form that a broker-dealer must file with its DEA that elicits information about the broker-dealer’s practices with respect to the custody of securities and funds of customers and non-customers.   

Amendments to Broker-Dealer Reporting, Audit, Notification, and Other Requirements

Requirement to File Reports.

Under the amendments, broker-dealers must prepare and file with the Commission annual reports consisting of a financial report and either a compliance report or an exemption report that are prepared by the broker-dealer, as well as certain reports that are prepared by the independent public accountant covering the financial report and the compliance report or the exemption report (collectively, the “annual reports”).  The compliance report and the exemption report are new reports required by the amendments.  A broker-dealer must prepare and file a compliance report if the firm did not claim it was exempt from Exchange Act Rule 15c3-3 throughout the most recent fiscal year.  A broker-dealer must prepare and file an exemption report if the firm did claim that it was exempt from Rule 15c3-3 throughout the most recent fiscal year.

The compliance report must contain statements regarding the broker-dealer’s compliance with Exchange Act Rules 15c3-1 and 15c3-3(e) and the broker-dealer’s internal control over compliance with Rules 15c3-1, 15c3-3, Exchange Act Rule 17a-13, and applicable DEA rules that require broker-dealers to send account statements to customers (collectively, the “financial responsibility rules”).  The compliance report must also contain descriptions of each material weakness in the broker-dealer’s internal control over compliance and any instances of non-compliance with Rules 15c3-1 and 15c3-3(e).  The exemption report must contain statements regarding the broker-dealer’s claimed exemptions from Rule 15c3-3.  These statements must be made to the broker-dealer’s best knowledge and belief, identify and describe any exceptions to the claimed exemptions, and briefly describe the nature of each exception and the approximate dates on which the exceptions occurred.

Filing of Annual Reports with the Securities Investor Protection Corporation (“SIPC”).

Under the amendments, a broker-dealer that is a member of SIPC is required to file a copy of its annual reports with SIPC.

Engagement of the Accountant.

Under the amendments, a broker-dealer is no longer required to file with the Commission a material inadequacy report prepared by its independent public accountant.  Broker-dealers are required to engage an independent public accountant to prepare reports based on an examination of the broker-dealer’s financial report and either an examination of certain statements in the broker-dealer’s compliance report or a review of the broker-dealer’s exemption report.  The examinations and reviews must be made in accordance with standards of the Public Company Accounting Oversight Board.

Notification of Non-Compliance or Material Weakness.

Under the amendments, if the independent public accountant determines that a broker-dealer is not in compliance with any of the financial responsibility rules during the course of preparing its reports, the independent public accountant must immediately notify the broker-dealer’s chief financial officer of the nature of the non-compliance.  The broker-dealer must then provide notice in accordance with Rule 15c3-1, Rule 15c3-3, or Exchange Act Rule 17a-11 if the non-compliance requires the broker-dealer to provide notice under those rules and must provide a copy of the notification to the independent public accountant.

If the independent public accountant determines that a material weakness exists in the internal control over compliance of the broker-dealer, the accountant must immediately notify the broker-dealer’s chief financial officer of the nature of the material weakness.  The broker-dealer must then provide notice in accordance with Rule 17a-11 and provide a copy of the notification to the independent public accountant.

The broker-dealer is also required to provide a copy of the notice sent to the Commission to the accountant within one business day.  If the accountant does not receive the notice or if the accountant does not agree with any statements in the notice, the accountant is required to provide a report to the Commission and the broker-dealer’s DEA within one business day.  The report from the accountant would, if the broker-dealer failed to file a notice, describe any instances of non-compliance that required the broker-dealer to provide a notice.  If the broker-dealer filed a notice, but the accountant does not agree with the statements in the notice, the report from the accountant would detail the aspects of the broker-dealer’s notice with which the accountant does not agree.

Information Provided to Customers.

Under the amendments, if the independent public accountant’s report covering the compliance report identifies the existence of one or more material weaknesses, the broker-dealer must include a statement in the financial information it sends to its customers that material weaknesses have been identified and that a copy of the accountant’s report is available for customers’ inspection at the Commission’s principal office and the regional office in which the broker-dealer has its principal place of business.

Access to Accountant and Audit Documentation

Under the amendments, a carrying or clearing broker-dealer must represent in its notice designating its independent public accountant that, if requested in writing for purposes of the examination of the broker-dealer, the firm agrees to: (1) allow Commission and DEA examination staff to review the audit documentation associated with its annual audit reports; and (2) allow its independent public accountant to discuss its findings with examination staff.

Form Custody

Under the amendments, all broker-dealers are required to file new Form Custody with their quarterly FOCUS Reports.  Form Custody is designed to elicit information concerning whether a broker-dealer maintained custody of customer and non-customer assets, and, if so, how such assets were maintained.

Effective Dates

The effective date for the requirement to file Form Custody and the requirement to file annual reports with SIPC is December 31, 2013.  The effective date for the requirements relating to broker-dealer annual reports is June 1, 2014.

Other Resources

The adopting release for these amendments can be found on the Commission’s website at http://www.sec.gov/rules/final/2013/34-70073.pdf. The proposing release can be found on the Commission’s website at http://www.sec.gov/rules/proposed/2011/34-64676.pdf.

Contacting the Commission

The Commission’s Division of Trading and Markets is available to assist small entities with questions regarding these amendments.  Questions may be directed to the Division of Trading and Markets by email at tradingandmarkets@sec.gov or by telephone at (202) 551-5777.

¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.