# Broker-Dealer Reports > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2013-18738 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** August 21, 2013 - **Citation:** 78 FR 51910 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 240 and 249 [Release No. 34-70073; File No. S7-23-11] RIN 3235-AK56 Broker-Dealer Reports AGENCY: Securities and Exchange Commission. ACTION: Final rule. SUMMARY: The Securities and Exchange Commission (“Commission”), under the Securities Exchange Act of 1934 (“Exchange Act”), is amending certain broker-dealer annual reporting, audit, and notification requirements. The amendments include a requirement that broker-dealer audits be conducted in accordance with standards of the Public Company Accounting Oversight Board (“PCAOB”) in light of explicit oversight authority provided to the PCAOB by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) to oversee these audits. The amendments further 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 the findings relating to the reports of the accountant with those representatives when requested in connection with a regulatory examination of the broker-dealer. Finally, the amendments require a broker-dealer to file a new form 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. DATES: This rule is effective June 1, 2014, except the amendment to § 240.17a-5(e)(5), which is effective October 21, 2013 and the amendments to § 240.17a-5(a) and (d)(6) and § 249.639, which are effective December 31, 2013. FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate Director, at (202) 551-5525; Thomas K. McGowan, Deputy Associate Director, at (202) 551-5521; Randall W. Roy, Assistant Director, at (202) 551-5522; Mark M. Attar, Branch Chief, at (202) 551-5889; Rose Russo Wells, Special Counsel, at (202) 551-5527; Sheila Dombal Swartz, Special Counsel, at (202) 551-5545; or Kimberly N. Chehardy, Attorney, at (202) 551-5791, Office of Financial Responsibility, Division of Trading and Markets; or Kevin Stout, Senior Associate Chief Accountant, at (202) 551-5930, Office of the Chief Accountant, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010. SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to Rule 17a-5 (17 CFR 240.17a-5) and technical and conforming amendments to Rule 17a-11 (17 CFR 240.17a-11) and is adopting Form Custody (17 CFR 249. 639) under the Exchange Act. Contents I. Background A. Overview B. Rules Governing Broker-Dealer Financial and Custodial Responsibility 1. The Broker-Dealer Net Capital Rule 2. The Broker-Dealer Customer Protection Rule 3. The Broker-Dealer Quarterly Securities Count Rule 4. The Broker-Dealer Account Statement Rules II. Final Amendments to Broker-Dealer Reporting, Audit, Notification, and Other Requirements A. Overview of New Requirements B. Annual Reports To Be Filed—Paragraph (d) of Rule 17a-5 1. Requirement To File Reports—Paragraph (d)(1) of Rule 17a-5 i. Proposed Amendments ii. Comments Received iii. The Final Rule 2. The Financial Report—Paragraph (d)(2) of Rule 17a-5 3. The Compliance Report—Paragraph (d)(3) of Rule 17a-5 i. The Proposed Amendments ii. Comments Received iii. The Final Rule 4. The Exemption Report—Paragraph (d)(4) of Rule 17a-5 i. Proposed Amendments ii. Comments Received iii. The Final Rule 5. Time for Filing Annual Reports—Paragraph (d)(5) of Rule 17a-5 6. Filing of Annual Reports with SIPC—Paragraph (d)(6) of Rule 17a-5 i. The Proposed Amendments ii. Comments Received iii. The Final Rule C. The Nature and Form of the Annual Reports 1. Exemptions From Audit Requirement—Paragraph (e)(1) of Rule 17a-5 2. Affirmation—Paragraph (e)(2) of Rule 17a-5 3. Confidentiality of Annual Reports—Paragraph (e)(3) of Rule 17a-5 4. Supplemental Report on SIPC Membership—Paragraph (e)(4) of Rule 17a-5 D. Engagement of the Accountant 1. Statutory Requirements and Commission Authority 2. Engagement of Accountant Requirements Prior to Today's Amendments 3. Amended Engagement of Accountant Requirements i. Proposed Amendments ii. Comments iii. The Final Rule E. PCAOB Registration of Independent Public Accountant—Paragraph (f)(1) of Rule 17a-5 F. Notification of Non-Compliance or Material Weakness 1. New Notification Requirements—Paragraph (h) of Rule 17a-5 i. The Proposed Amendments ii. Comments Received iii. The Final Rule 2. Conforming and Technical Amendments to Rule 17a-11 G. Other Amendments to Rule 17a-5 1. Information Provided to Customers—Paragraph (c) of Rule 17a-5 i. Background ii. Availability of Independent Public Accountant's Comments on Material Inadequacies—Paragraph (c)(2) of Rule 17a-5 iii. Exemption From Mailing Financial Information to Customers—Paragraph (c)(5) of Rule 17a-5 2. Technical Amendments i. Deletion of Paragraph (b)(6) of Rule 17a-5 ii. Deletion of Provisions Relating to the Year 2000 iii. Deletion of Paragraph (i)(5) of Rule 17a-5 iv. Amendments to Paragraph (f)(2) of Rule 17a-5 v. Further Technical Amendments H. Coordination With Investment Advisers Act Rule 206(4)-2 1. Background 2. Rule 206(4)-2 3. Broker-Dealers Acting as Qualified Custodians Under Rule 206(4)-2 4. Proposal To Allow Report Based on Examination of Compliance Report to Satisfy Rule 206(4)-2 i. The Proposal ii. Comments on the Proposal 5. Adoption of Proposal Relating to Rule 206(4)-2 III. Access to Accountant and Audit Documentation IV. Form Custody A. Background B. Filing of Form Custody 1. Requirement to File Form Custody with FOCUS Reports 2. Requests for Exemption From Filing Form Custody 3. Attest Engagement Not Required for Form Custody C. Form Custody 1. Item 1—Accounts Introduced on a Fully Disclosed Basis 2. Item 2—Accounts Introduced on an Omnibus Basis 3. Item 3—Carrying Broker-Dealers i. Items 3.A and 3.B ii. Item 3.C a. Background b. General Comments to Item 3.C c. Item 3.C.i d. Item 3.C.ii e. Item 3.C.iii iii. Items 3.D and 3.E a. Items 3.D.i and 3.E.i b. Items 3.D.ii and 3.E.ii c. Items 3.D.iii and 3.E.iii 4. Item 4—Carrying for Other Broker-Dealers 5. Item 5—Trade Confirmations 6. Item 6—Account Statements 7. Item 7—Electronic Access to Account Information 8. Item 8—Broker-Dealers Registered as Investment Advisers 9. Item 9—Broker-Dealers Affiliated with Investment Advisers V. Effective Dates A. Amendments Effective 60 Days After Publication in the Federal Register B. Amendments Effective on December 31, 2013 C. Amendments Effective on June 1, 2014 VI. Paperwork Reduction Act A. Summary of the Collection of Information Requirements B. Use of Information C. Respondents D. Total Initial and Annual Burdens 1. Annual Reports To Be Filed i. The Financial Report ii. The Compliance Report iii. The Exemption Report iv. Additional Burden and Cost To File the Annual Reports v. Supplemental Report on SIPC Membership vi. Statement Regarding Independent Public Accountant vii. External Costs of Engagement of Accountant a. Financial Report (including Change from GAAS to PCAOB Standards) b. Compliance Report c. Exemption Report d. Access to Accountant and Audit Documentation 2. Conforming and Technical Amendments to Rule 17a-11 3. Form Custody E. Collection of Information Is Mandatory F. Confidentiality VII. Economic Analysis A. Motivation for the Amendments B. Economic Baseline 1. Broker-Dealers 2. Independent Public Accountants That Audit Broker-Dealer Reports 3. SIPC Lawsuits Against Accountants 4. Overview of Broker-Dealer Reporting, Auditing, and Notification Requirements Before Today's Amendments i. Broker-Dealer Reporting ii. Engagement of the Accountant iii. Filing of Annual Reports with SIPC iv. Notification Requirements v. Information Provided to Customers vi. Access to Accountants and Audit Documentation vii. Form Custody C. Costs and Benefits of the Rule Amendments 1. Broker-Dealer Annual Reporting Amendments i. Changing the Broker-Dealer Audit Standard Setter From the AICPA to the PCAOB and the Standards From GAAS to PCAOB Standards ii. Requirement To File New Reports a. Compliance Report b. Exemption Report iii. Engagement of the Accountant iv. Filing of Annual Reports With SIPC v. Notification Requirements a. Amendments to Rule 17a-5 b. Conforming and Technical Amendments to Rule 17a-11 vi. Information Provided to Customers vii. Coordination With Investment Advisers Act Rule 206(4)-2 2. Access to Accountant and Audit Documentation 3. Form Custody 4. Consideration of Burden on Competition, and Promotion of Efficiency, Competition, and Capital Formation VIII. Final Regulatory Flexibility Analysis A. Need for and Objectives of the Amendments and New Form B. Significant Issues Raised by Public Comments C. Small Entities Subject to the Rules D. Reporting, Recordkeeping, and Other Compliance Requirements E. Agency Action To Minimize Effect on Small Entities IX. Statutory Authority I. Background A. Overview In 2009, the Commission began reviewing rules regarding the safekeeping of investor assets in connection with several cases the Commission brought alleging fraudulent conduct by investment advisers and broker-dealers, including, among other things, misappropriation or other misuse of customer securities and funds. 1 As part of the rule review effort, the Commission amended Rule 206(4)-2 under the Investment Advisers Act of 1940 (“Rule 206(4)-2”), which governs the custody of client securities and funds by investment advisers. 2 When adopting this amendment, the Commission stated that it represented “a first step in the effort to enhance custody protections, with consideration of additional enhancements of the rules governing custody of customer assets by broker-dealers to follow.” 3 1 See, e.g., SEC v. Bernard L. Madoff, et al., Litigation Release No. 20889 (Feb. 9, 2009); SEC v. Stanford International Bank, et al., Litigation Release No. 20901 (Feb. 17, 2009); SEC v. Donald Anthony Walker Young, et al., Litigation Release No. 21006 (Apr. 20, 2009); SEC v. Isaac I. Ovid, et al., Litigation Release No. 20998 (Apr. 14, 2009); SEC v. The Nutmeg Group, LLC, et al., Litigation Release No. 20972 (Mar. 25, 2009); SEC v. WG Trading Investors, L.P., et al., Litigation Release No. 20912 (Feb. 25, 2009). 2 See Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act of 1940 (“Advisers Act”) Release No. 2968 (Dec. 30, 2009), 75 FR 1456 (Jan. 11, 2010). See also 17 CFR 275.206(4)-2. 3 See Custody of Funds or Securities of Clients by Investment Advisers, 75 FR at 1456. In June 2011, the Commission proposed rule amendments and a new form designed, among other things, to provide additional safeguards with respect to broker-dealer custody of customer securities and funds. 4 The proposed amendments would have amended certain annual reporting, audit, and notification requirements for broker-dealers. 5 The proposed amendments also would have required a broker-dealer that clears transactions or carries customer accounts (each, a “clearing broker-dealer”) to agree to allow representatives of the Commission or the broker-dealer's DEA to review the documentation associated with certain reports of the broker-dealer's independent public accountant and to allow the accountant to discuss with representatives of the Commission or DEA the accountant's findings associated with those reports when requested in connection with an examination of the broker-dealer. 6 Further, the proposed amendments would have required a broker-dealer to file with its DEA on a quarterly basis a new form—Form Custody—that would have elicited information as to whether, and if so how, a broker-dealer maintains custody of securities and funds of customers and others. 7 The Commission also proposed requiring that a broker-dealer file its annual reports with the Securities Investor Protection Corporation (“SIPC”). 8 4 See Broker-Dealer Reports, Exchange Act Release No. 64676 (June 15, 2011), 76 FR 37572 (June 27, 2011). 5 Id. at 37575-37583. 6 Id. at 37583-37584. 7 Id. at 37584-37592. 8 Id. at 37592-37594. The proposed amendments were designed to enhance the ability of the Commission to oversee broker-dealer custody practices and, among other things, to: (1) Increase the focus of broker-dealers that maintain custody of customer funds and securities (“carrying broker-dealers”) and their independent public accountants on compliance, and internal control over compliance, with certain financial and custodial requirements; (2) strengthen and clarify broker-dealer audit and reporting requirements in order to facilitate consistent compliance with these requirements; (3) facilitate the ability of the PCAOB to implement the explicit oversight authority over broker-dealer audits provided to the PCAOB by the Dodd-Frank Act; 9 (4) ensure that SIPC receives the necessary information to assess whether the liquidation fund it maintains is appropriately sized to the risks of a large broker-dealer failure; (5) enable Commission and DEA examiners to conduct risk-based examinations of carrying and clearing broker-dealers by assisting the examiners in selecting areas of focus for their examinations; and (6) provide the Commission and the DEAs with a comprehensive overview of a broker-dealer's custody practices. 10 9 Public Law 111-203, 124 Stat. 1376, H.R. 4173 (July 21, 2010). 10 The proposed amendments also were designed to avoid duplicative requirements for broker-dealers that are dually-registered as investment advisers in view of the internal control report requirement that was added by the amendment to Rule 206(4)-2. See discussion below in section VII.A. of this release identifying further motivations for the amendments. The Commission received 27 comment letters on the proposal. 11 The Commission has considered the comments and, as discussed in detail below, is adopting the amendments and the new form with modifications, in part in response to comments received. A number of commenters stated that the Commission should coordinate with the Commodity Futures Trading Commission (“CFTC”) to account for broker-dealers that also are registered as futures commission merchants (“FCMs”) in order to align the broker-dealer reporting and audit requirements with FCM reporting and audit requirements. 12 The Commission staff is in discussions with the CFTC staff concerning ways to align the reporting and audit requirements for dually-registered broker-dealer/FCMs with the goal of coordinating these requirements, including the requirements that the Commission is adopting today. 11 Comment letter of Naphtali M. Hamlet (June 22, 2011) (“ Hamlet Letter ”); comment letter of Robert R. Kelley (June 27, 2011) (“ Kelley Letter ”); comment letter of Chris Barnard (July 20, 2011) (“ Barnard Letter ”); comment letter of Suzanne Shatto (July 25, 2011) (“ Shatto Letter ”); comment letter of Suzanne H. Shatto (July 25, 2011) (“ Shatto Letter II ”); comment letter of Todd Genger (Aug. 2, 2011) (“ Genger Letter ”); comment letter of Suzanne Shatto (Aug. 14, 2011) (“ Shatto Letter III ”); comment letter of Deloitte & Touche LLP (Aug. 25, 2011) (“ Deloitte Letter ”); comment letter of the Securities Industry and Financial Markets Association (Aug. 25, 2011) (“ SIFMA Letter ”); comment letter of the Center for Audit Quality (Aug. 25, 2011) (“ CAQ Letter ”); comment letter of KPMG LLP (Aug. 25, 2011) (“ KPMG Letter ”); comment letter of PricewaterhouseCoopers, LLP (Aug. 25, 2011) (“ PWC Letter ”); comment letter of Citrin Cooperman & Co., LLP (Aug. 25, 2011) (“ Citrin Letter ”); comment letter of Grant Thornton LLP (Aug. 26, 2011) (“ Grant Thornton Letter ”); comment letter of James J. Angel (Aug. 26, 2011) (“ Angel Letter ”); comment letter of James J. Angel (Aug. 26, 2011) (“ Angel Letter II ”); comment letter of McGladrey & Pullen, LLP (Aug. 26, 2011) (“ McGladrey Letter ”); comment letter of the Certified Financial Planner Board of Standards, Inc. (Aug. 26, 2011) (“ CFP Letter ”); comment letter of Integrated Management Solutions USA LLC (Aug. 26, 2011) (“ IMS Letter ”); comment letter of the American Institute of Certified Public Accountants (Aug. 26, 2011) (“ AICPA Letter ”); comment letter of the Committee of Annuity Insurers (Aug. 26, 2011) (“ CAI Letter ”); comment letter of Ernst & Young LLP (Aug. 26, 2011) (“ E&Y Letter ”); comment letter of Van Kampen Funds Inc. and Invesco Distributors, Inc. (Aug. 26, 2011) (“ Van Kampen/Invesco Letter ”); comment letter of Suzanne H. Shatto (Sept. 13, 2011) (“ Shatto Letter IV ); comment letter N.M. Hamlet (Sept. 14, 2011) (“ Hamlet Letter II ”); comment letter of the Federal Regulation of Securities Committee, Business Law Section, American Bar Association (Sept. 15, 2011) (“ ABA Letter ”); and comment letter of the Committee of Annuity Insurers (Apr. 17, 2012) (“ CAI II Letter” ). The comment letters are available on the Commission's Web site at http://www.sec.gov/comments/s7-23-11/s72311.shtml . Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC (File No. S7-23-11). 12 See CAQ Letter; Deloitte Letter; E&Y Letter; Grant Thornton Letter; KPMG Letter; PWC Letter. B. Rules Governing Broker-Dealer Financial and Custodial Responsibility Rule 15c3-1, 13 Rule 15c3-3, 14 and Rule 17a-13, 15 under the Exchange Act and applicable DEA rules that require broker-dealers to periodically send account statements to customers (“Account Statement Rules”) 16 (collectively for the purposes of this release, “the financial responsibility rules”) are central to today's amendments to the broker-dealer reporting, audit, and notification requirements. In light of the significance of the financial responsibility rules to today's amendments, the following section briefly summarizes the requirements of each rule in order to provide a foundation for the later discussion of the amendments. 13 17 CFR 240.15c3-1 (a rule prescribing net capital requirements for broker-dealers). 14 17 CFR 240.15c3-3 (a rule prescribing requirements regarding the holding of customer securities and funds by broker-dealers). 15 17 CFR 240.17a-13 (a rule requiring broker-dealers to perform quarterly securities counts). 16 See, e.g., Rule 9.12 of the Chicago Board Options Exchange (“CBOE”); NASD Rule 2340 of the Financial Industry Regulatory Authoirty (“FINRA”). 1. The Broker-Dealer Net Capital Rule Rule 15c3-1 requires broker-dealers to maintain a minimum level of net capital (consisting of highly liquid assets) at all times. 17 In computing net capital, a broker-dealer must, among other things, calculate net worth in accordance with U.S. generally accepted accounting principles (“GAAP”) and then make certain adjustments to net worth, such as deducting illiquid assets and taking other capital charges and adding qualifying subordinated loans. 18 The amount remaining after these deductions is defined as “tentative net capital.” 19 The final step in computing net capital is to deduct certain percentages (“haircuts”) from the market value of the broker-dealer's proprietary positions to account for the market risk inherent in the positions 20 and to create a buffer of liquidity to protect against other risks associated with the broker-dealer's business. 21 The broker-dealer must cease conducting a securities business if the amount of net capital maintained by the firm falls below the minimum required amount. 22 17 See 17 CFR 240.15c3-1. The rule requires that a broker-dealer perform two calculations: (1) A computation of the minimum amount of net capital the broker-dealer must maintain; and (2) a computation of the amount of net capital the broker-dealer is maintaining. See 17 CFR 240.15c3-1(a) and (c)(2). The computation of net capital is based on the definition of the term “net capital” in paragraph (c)(2) of Rule 15c3-1. Id. Generally, a broker-dealer's minimum net capital requirement is the greater of a fixed-dollar amount specified in the rule and an amount determined by applying one of two financial ratios. See 17 CFR 240.15c3-1(a). 18 See 17 CFR 240.15c3-1(c)(2)(i)-(xiii). 19 See 17 CFR 240.15c3-1(c)(15). 20 See 17 CFR 240.15c3-1(c)(2)(vi). 21 See, e.g., Uniform Net Capital Rule, Exchange Act Release No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977). 22 See 15 U.S.C. 78o(c)(3)(A). 2. The Broker-Dealer Customer Protection Rule Rule 15c3-3 imposes two key requirements on a carrying broker-dealer: first, the broker-dealer must maintain physical possession or control over customers' fully paid and excess margin securities; 23 and second, the firm must maintain a reserve of funds or qualified securities 24 in an account at one or more banks that is at least equal in value to the amount of net funds owed to customers. 25 These requirements are designed to protect customers by requiring broker-dealers to segregate customers' securities and funds from the broker-dealer's proprietary business activities. If the broker-dealer fails financially, customers' securities and funds should be readily available to be returned to customers. In addition, if the failed broker-dealer is liquidated in a proceeding under the Securities Investor Protection Act of 1970 (“SIPA”), as amended, the customers' securities and funds should be isolated and readily identifiable as “customer property” and, consequently, available to be distributed to customers ahead of other creditors. 26 23 See 17 CFR 240.15c3-3(d). Control means the broker-dealer must hold these securities free of lien in one of several locations specified in the rule ( e.g., at a bank or clearing agency). See 17 CFR 240.15c3-3(c). The broker-dealer must make a daily determination from its books and records (as of the preceding day) of the quantity of fully paid and excess margin securities not in its possession or control. See 17 CFR 240.15c3-3(d). If the amount in the broker-dealer's possession or control is less than the amount indicated as being held for customers on the broker-dealer's books and records, the broker-dealer generally must initiate steps to retrieve customer securities from non-control locations or otherwise obtain possession of them or place them in control locations. Id. The terms fully paid securities, margin securities, and excess margin securities are defined in Rule 15c3-3. See 17 CFR 240.15c3-3(a)(3), (a)(4), and (a)(5), respectively. 24 The term qualified security is defined in Rule 15c3-3 to mean a security issued by the U.S. or a security in respect of which the principal and interest are guaranteed by the U.S. See 17 CFR 240.15c3-3(a)(6). 25 See 17 CFR 240.15c3-3(e). The amount of the net funds owed to customers (“customer reserve requirement”) is computed by adding customer credit items ( e.g., cash in securities accounts) and subtracting from that amount customer debit items ( e.g., margin loans) pursuant to a formula in Exhibit A to Rule 15c3-3. See 17 CFR 240.15c3-3a. Carrying broker-dealers are required to compute the customer reserve requirement on a weekly basis, except where customer credit balances do not exceed $1 million (in which case the computation can be performed monthly, although the broker-dealer must maintain 105% of the required deposit amount and may not exceed a specified aggregate indebtedness limit). See 17 CFR 240.15c3-3(e)(3). 26 See 15 U.S.C. 78aaa et seq. Provisions of Rule 15c3-3 exempt a broker-dealer from the requirements of Rule 15c3-3 under certain circumstances. 27 Generally, a broker-dealer is exempt from Rule 15c3-3 if it does not hold customer securities or funds, or, if it does receive customer securities or funds, it promptly delivers the securities or promptly transmits the funds to appropriate persons. 28 27 See 17 CFR 240.15c3-3(k). 28 Id. 3. The Broker-Dealer Quarterly Securities Count Rule Rule 17a-13 generally requires a broker-dealer that maintains custody of securities (proprietary, customer, or both), on a quarterly basis, to physically examine and count the securities it holds, account for the securities that are subject to its control or direction but are not in its physical possession ( e.g., securities held at a control location), verify the locations of securities under certain circumstances, and compare the results of the count and verification with its records. 29 In accordance with a schedule, the broker-dealer must take an operational capital charge under Rule 15c3-1 for short securities differences (which include securities positions reflected on the broker-dealer's securities record that are not susceptible to either count or confirmation) that are unresolved after discovery. 30 The differences also must be recorded in the broker-dealer's books and records. 31 29 See 17 CFR 240.17a-13(b). 30 See 17 CFR 240.15c3-1(c)(2)(v). 31 See 17 CFR 240.17a-3(a)(4)(vi). 4. The Broker-Dealer Account Statement Rules The Account Statement Rules of DEAs require member broker-dealers to send, at least once every calendar quarter, a statement of account containing a description of any securities positions, money balances, or account activity to each customer whose account had a security position, money balance, or account activity during the period since the last such statement was sent to the customer. 32 The Account Statement Rules provide a key safeguard for customers by requiring that they receive information concerning securities positions and other assets held in their accounts on a regular basis, which they can use to identify discrepancies and monitor the performance of their accounts. 32 See, e.g., CBOE Rule 9.12; NASD Rule 2340. II. Final Amendments to Broker-Dealer Reporting, Audit, Notification, and Other Requirements A. Overview of New Requirements The Commission is adopting amendments to the reporting, audit, and notification requirements in Rule 17a-5, and additional amendments to other provisions of the rule, including technical changes. The Commission also is adopting amendments to the notification requirements in Rule 17a-11, and certain other technical amendments to that rule. Under the amendments to the reporting and audit requirements, broker-dealers must, among other things, 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 an independent public accountant covering the financial report and the compliance report or the exemption report. 33 The filing of a compliance or exemption report and the related report of the independent public accountant are new requirements. The financial report must contain the same types of financial statements that were required to be filed under Rule 17a-5 prior to these amendments (a statement of financial condition, a statement of income, a statement of cash flows, and certain other financial statements). 34 In addition, the financial report must contain, as applicable, the supporting schedules that were required to be filed under Rule 17a-5 prior to these amendments (a computation of net capital under Rule 15c3-1, a computation of the reserve requirements under Rule 15c3-3, and information relating to the possession or control requirements under Rule 15c3-3). 35 33 See paragraph (d) of Rule 17a-5. 34 See paragraph (d)(2)(i) of Rule 17a-5. The requirements for the financial report are discussed below in more detail in section II.B.2. of this release. 35 See paragraph (d)(2)(ii) of Rule 17a-5. A broker-dealer that did not claim that it was exempt from Rule 15c3-3 throughout the most recent fiscal year must file the compliance report, and a broker-dealer that did claim it was exempt from Rule 15c3-3 throughout the most recent fiscal year (generally, a “non-carrying broker-dealer”) must file the exemption report. 36 Broker-dealers must make certain statements and provide certain information relating to the financial responsibility rules in these reports. 37 36 See paragraphs (d)(1)(i)(B)( 1 ) and ( 2 ) of Rule 17a-5. 37 See paragraphs (d)(3) and (4) of Rule 17a-5. The requirements for the compliance report and the exemption report are discussed below in more detail in section II.B.3. and section II.B.4. of this release, respectively. In addition to preparing and filing the financial report and the compliance report or exemption report, a broker-dealer must engage a PCAOB-registered independent public accountant to prepare a report based on an examination of the broker-dealer's financial report in accordance with PCAOB standards. 38 A carrying broker-dealer also must engage the PCAOB-registered independent public accountant to prepare a report based on an examination of certain statements in the broker-dealer's compliance report. 39 A non-carrying broker-dealer must engage the PCAOB-registered independent public accountant to prepare a report based on a review of certain statements in the broker-dealer's exemption report. 40 In each case, the examination or review must be conducted in accordance with PCAOB standards. The broker-dealer must file these reports with the Commission along with the financial report and the compliance report or exemption report prepared by the broker-dealer. 41 38 See paragraphs (f)(1) and (g)(1) of Rule 17a-5. 39 See paragraphs (f)(1) and (g)(2)(i) of Rule 17a-5. 40 See paragraphs (f)(1) and (g)(2)(ii) of Rule 17a-5. 41 See paragraph (d)(1)(i)(C) of Rule 17a-5. The requirements for the engagement of the independent public accountant are discussed below in more detail in section II.D.3. of this release. The annual reports also must be filed with SIPC if the broker-dealer is a member of SIPC. 42 In addition, broker-dealers must generally file with SIPC a supplemental report on the status of the membership of the broker-dealer in SIPC. 43 The supplemental report must include a report of the independent public accountant that covers the SIPC annual general assessment reconciliation or exclusion from membership forms based on certain procedures specified in the rule. In the future, SIPC may determine the format of this report by rule, subject to Commission approval. 44 42 See paragraph (d)(6) of Rule 17a-5. This requirement is discussed below in more detail in section II.B.6. of this release. 43 See paragraph (e)(4) of Rule 17a-5. This requirement is discussed below in more detail in section II.C.4. of this release. 44 Id. Currently, Rule 17a-5 prescribes the format of the report. See 17 CFR 240.17a-5. Finally, the PCAOB-registered independent public accountant must immediately notify the broker-dealer if the accountant determines during the course of preparing the accountant's reports that the broker-dealer is not in compliance with the financial responsibility rules or if the accountant determines that any material weakness exists in the broker-dealer's internal control over compliance with the financial responsibility rules. 45 The broker-dealer, in turn, must file a notification with the Commission and its DEA under Rule 15c3-1, Rule 15c3-3, or Rule 17a-11 if the independent public accountant's notice concerns an instance of non-compliance that would trigger notification under those rules. 46 Under the amendments to Rule 17a-11, a broker-dealer also must file a notification with the Commission and its DEA if the broker-dealer discovers or is notified by the independent public accountant of the existence of any material weakness (as defined in the amendments) in the broker-dealer's internal control over compliance with the financial responsibility rules. 47 45 See paragraph (h) of Rule 17a-5. As discussed below, material weakness is defined for purposes of the compliance report and, therefore, the notification of a material weakness only can occur in the context of the audit of a broker-dealer that files a compliance report. 46 Id. Notifications under Rule 17a-11 also must be filed with the CFTC if the broker-dealer is registered as a FCM with the CFTC. See 17 CFR 240.17a-11(g). 47 See paragraph (e) of Rule 17a-11. These notification provisions are discussed below in more detail in section II.F. of this release. Each of these amendments is discussed in more detail in the following sections of this release. B. Annual Reports To Be Filed—Paragraph (d) of Rule 17a-5 Prior to today's amendments, paragraph (d) of Rule 17a-5 generally required a broker-dealer to annually file the financial statements and supporting schedules discussed below in section II.B.2. of this release and a report prepared by the broker-dealer's independent public accountant covering the financial statements and supporting schedules. 48 The Commission proposed amendments that would, among other things, restructure paragraph (d) and—as part of the proposed revisions to the attestation engagement provisions—add the requirement that a broker-dealer file either a compliance report or an exemption report, as applicable, and a report prepared by the broker-dealer's independent public accountant based on an examination of the compliance report or a review of the exemption report. 49 As discussed in sections II.B.1. through II.B.6. of this release, the Commission is adopting the proposed amendments to paragraph (d) with modifications. 50 48 See 17 CFR 240.17a-5(d)(1)(i). Certain types of broker-dealers were exempt from the requirement to file the reports or to file reports that had been audited by an independent public accountant. See 17 CFR 240.17a-5(d)(1)(ii)-(iii). 49 See Broker-Dealer Reports, 76 FR at 37575-37581. 50 Before today's amendments, paragraph (d) of Rule 17a-5 was titled “Annual filing of audited financial statements.” In the proposing release, the Commission proposed to change the title to “Annual reports” to reflect that, under the proposed amendments to paragraph (d), broker-dealers would be required to prepare and file two reports with the Commission—a financial report and a compliance report or an exemption report. See Broker-Dealer Reports, 76 FR at 37575. The Commission received no comments on this proposal and is adopting the new title as proposed. See paragraph (d) of Rule 17a-5. In addition, the Commission is making a technical amendment to paragraph (d) of Rule 17a-5 to replace the term “fiscal or calendar year” with the term “fiscal year.” The Commission is adopting this technical amendment because the term “fiscal year” includes instances in which December 31st, i.e., the calendar year end, is the broker-dealer's fiscal year end. 1. Requirement To File Reports—Paragraph (d)(1) of Rule 17a-5 i. Proposed Amendments The Commission proposed to amend paragraph (d)(1) of Rule 17a-5 51 to require that a broker-dealer file a financial report containing financial statements and supporting schedules and either a compliance report or an exemption report, as applicable. 52 The proposal provided that a broker-dealer must file a compliance report “unless the [broker-dealer] is exempt from the provisions of [Rule 15c3-3]” in which case the broker-dealer would be required to file an exemption report. 53 The proposed amendments also would have required a broker-dealer generally to file reports prepared by an independent public accountant covering the financial report and compliance report or exemption report, as applicable, unless the broker-dealer was exempt from the requirement to file the reports or from the requirement to engage an independent public accountant with respect to the reports. 54 To accommodate these changes, the Commission also proposed to reorganize the provisions of paragraph (d)(1) of Rule 17a-5, and to make other technical amendments. 55 51 See 17 CFR 240.17a-5(d)(1). 52 See Broker-Dealer Reports, 76 FR at 37575. 53 Id. 54 Id. 55 Id. at 37575-37578, 37603-37604. The proposed amendments with respect to the compliance report and exemption report set forth different requirements for carrying broker-dealers as compared with broker-dealers that do not hold customer securities and funds. 56 In order to provide clarity with respect to this distinction, the proposed amendments referenced Rule 15c3-3, which applies to carrying broker-dealers and contains provisions under which a broker-dealer is exempt from the requirements in the rule. The goal was to establish a clear way of determining whether a broker-dealer would need to file a compliance report or an exemption report. However, not all broker-dealers that are subject to Rule 15c3-3 regularly hold customer securities or funds. This prompted the Commission to inquire in the proposing release as to whether there are broker-dealers that would not qualify to file the proposed exemption report because they are not exempt from Rule 15c3-3, but that should be allowed to file a more limited report than the proposed compliance report based on the limited scope of their business. 57 56 Id. at 37575-37578, 37580-37581 (discussing the compliance report and exemption report, respectively). 57 Id. at 37581. ii. Comments Received The Commission received several comments on its proposed amendments to paragraph (d)(1) of Rule 17a-5. 58 Some commenters asked whether the provision that would require the broker-dealer to file an exemption report instead of a compliance report related to a period end date or to a period of time. 59 Further, as discussed in more detail in sections II.B.4. and II.D.3. of this release, commenters raised questions and concerns about how instances of exceptions to meeting the exemption provisions of paragraph (k) of Rule 15c3-3 would be treated under the proposed reporting requirements. 60 One commenter also stated that “limited purpose” carrying broker-dealers should not be required to file a compliance report, and broker-dealers with certain business model characteristics should not be required to file the compliance report. 61 Similarly, another commenter stated that broker-dealers engaging exclusively in proprietary trading or investment banking may not technically be exempt from Rule 15c3-3 but nonetheless should not have to file the compliance report as they do not have “customers.” 62 Finally, one commenter stated that the Commission should clarify who must sign the compliance reports and exemption reports and the liability that attaches in the event of a misstatement or omission in the reports. 63 58 See, e.g., CAI Letter; CAI II Letter; CAQ Letter; Citrin Letter; Deloitte Letter; Grant Thornton Letter; KPMG Letter; McGladrey Letter. 59 See CAQ Letter; Deloitte Letter; Grant Thornton Letter; KPMG Letter. 60 See CAI Letter; SIFMA Letter. 61 See CAI Letter; CAI II Letter. 62 See McGladrey Letter. 63 See CAI Letter. iii. The Final Rule After considering these comments, the Commission is adopting the proposed amendments with certain modifications. 64 Under the final rule, all broker-dealers generally must prepare and file a financial report and either the compliance report or the exemption report. 65 A broker-dealer that did not claim an exemption from Rule 15c3-3 at any time during the most recent fiscal year or claimed an exemption for only part of the fiscal year must prepare and file the compliance report. 66 A broker-dealer must prepare and file the exemption report if the firm did claim that it was exempt from Rule 15c3-3 throughout the most recent fiscal year. 67 Broker-dealers also must file reports prepared by a PCAOB-registered independent public accountant covering the financial report and the compliance report or exemption report, as applicable. 68 64 See paragraph (d)(1) of Rule 17a-5. Paragraph (d)(1)(iii) of Rule 17a-5 (now re-designated as paragraph (d)(1)(iv)) contains an exemption from filing an annual report if the broker-dealer is a member of a national securities exchange and has transacted business in securities solely with or for other members of a national securities exchange, and has not carried any margin account, credit balance or security for any person who is defined as a “customer” in paragraph (c)(4) of Rule 17a-5. See paragraph (d)(1)(iv) of Rule 17a-5. The Commission also proposed to move the exemptions from having to file financial statements under paragraph (d) of Rule 17a-5 from paragraphs (d)(1)(ii) and (d)(1)(iii) of Rule 17a-5 to paragraphs (d)(1)(iii) and (d)(1)(iv), respectively. The Commission received no comments on these amendments and is adopting them as proposed. See paragraphs (d)(1)(iii) and (d)(1)(iv) of Rule 17a-5. For clarity, the amendments to paragraph (d)(1)(i) of Rule 17a-5 include a reference to the exemptions from the requirement for a broker-dealer to file the annual reports so that the paragraph now states “[e]xcept as provided in paragraphs (d)(1)(iii) and (d)(1)(iv) of this section, every broker or dealer registered under section 15 of the Act must file annually . . . .” See paragraph (d)(1)(i) of Rule 17a-5. As proposed, the final rule provided that the reports must be filed annually “on a calendar or fiscal year basis.” The final rule deletes the phrase “on a calendar or fiscal year basis” as the rule provides elsewhere that the annual reports must be filed on a fiscal year basis. Id. In addition, the Commission proposed to move the requirement that reports under paragraph (d) of Rule 17a-5 be as of the same fixed or determinable date each year, unless a change is approved in writing by the broker-dealer's DEA, from paragraph (d)(1)(i) of Rule 17a-5 to paragraph (d)(1)(ii). The Commission received no comments on this proposed amendment and is adopting it substantially as proposed. See paragraph (d)(1)(ii) of Rule 17a-5. The final rule also includes a technical modification from the proposal to require that the reports required to be filed under paragraph (d) must be as of the same “fiscal year end each year,” rather than as of the same “fixed or determinable date each year.” See paragraph (d)(1)(ii) of Rule 17a-5. This change, by having the rule refer to the broker-dealer's “fiscal year,” eliminates outdated language and conforms the language in paragraph (d) of Rule 17a-5 to language in paragraph (n) of Rule 17a-5. See 17 CFR 240.17a-5(n). The final rule also adds a clarifying cross-reference to the provision in Rule 17a-5 pursuant to which a broker-dealer requests a change of its fiscal year end. See paragraph (d)(1)(i) of Rule 17a-5. Furthermore, the final rule requires that a copy of the written approval by the broker-dealer's DEA of a change in the broker-dealer's fiscal year be sent to the Commission's principal office in Washington, DC, in addition to the regional office of the Commission for the region in which the broker-dealer has its principal place of business. Id. This change is consistent with paragraph (n) of Rule 17a-5, which requires that when a broker-dealer changes its fiscal year, it must file a notice with the Commission's principal office in Washington, DC as well as the regional office of the Commission for the region in which the broker-dealer has its principal place of business. See 17 CFR 240.17a-5(n). 65 See paragraph (d)(1)(i) of Rule 17a-5. The financial report, compliance report, and exemption report are discussed below in more detail in sections II.B.2., II.B.3., and II.B.4., respectively, of this release. 66 See paragraph (d)(1)(i)(B)( 1 ) of Rule 17a-5. 67 See paragraph (d)(1)(i)(B)( 2 ) of Rule 17a-5. 68 See paragraph (d)(1)(i)(C) of Rule 17a-5. The proposed requirements and final rule with respect to the attestation engagement for the independent public accountant are discussed below in section II.D. of this release. The final rule is modified from the proposal in three key ways. First, the final rule provides that the broker-dealer must file the exemption report if it did “claim that it was exempt” from Rule 15c3-3 69 throughout the most recent fiscal year. 70 This modification from the proposal—which provided that a broker-dealer “shall” file the exemption report if the broker-dealer “is exempt from the provisions of [Rule 15c3-3]”—is designed to provide greater clarity as to whether a broker-dealer must file the exemption report (as opposed to the compliance report), particularly when the broker-dealer had exceptions to meeting the exemption provisions in paragraph (k) of Rule 15c3-3 during the fiscal year. 71 Specifically, if the broker-dealer claimed an exemption from Rule 15c3-3 in its Financial and Operational Combined Uniform Single Reports (“FOCUS Reports”) throughout the fiscal year, 72 it must file the exemption report even it had exceptions to the exemption provisions. 73 Consequently, the applicability of the exemption report under the final rule is based on an objective and easily ascertainable factor: whether the broker-dealer claimed an exemption from Rule 15c3-3 throughout the most recent fiscal year. 74 69 See paragraph (d)(1)(i)(B)(2) of Rule 17a-5. A broker-dealer claiming an exemption from Rule 15c3-3 is required to indicate the basis for the exemption on the periodic reports it files with securities regulators. See, e.g., Item 24 of Part IIa of the Financial and Operational Combined Uniform Single Report. See 17 CFR 249.617. 70 As discussed below in more detail in section II.B.4. of this release, the provisions of paragraph (k) of Rule 15c3-3 prescribe “exemptions” from the requirements of Rule 15c3-3. See 17 CFR 240.15c3-3(k)(1), (k)(2)(i), (k)(2)(ii), and (k)(3). 71 See CAI Letter; SIFMA Letter. 72 The FOCUS Reports are: Form X-17A-5 Schedule I; Form X-17A-5 Part II; Form X-17A-5 Part IIa; Form X-17A-5 Part IIb; and Form X-17A-5 Part III. 73 As discussed in detail below in section II.B.4. of this release, a broker-dealer that has exceptions to meeting the exemption provisions in paragraph (k) of Rule 15c3-3 must identify them in the exemption report. 74 See discussion in section II.B.4. of this release. There may be circumstances in which a broker-dealer has not held customer securities or funds during the fiscal year, but does not fit into one of the exemptive provisions listed under Item 24 of Part IIa. Even though there is not a box to check on the FOCUS Report, these broker-dealers should file an exemption report and related accountant's report. As noted above, several commenters argued that broker-dealers that engage in limited custodial activities and, therefore, are not exempt from Rule 15c3-3, should not be required to file a compliance report. 75 Specifically, one of these commenters suggested that a “new” category of “limited purpose” broker-dealer with certain business model characteristics should be addressed in the rule and that this “new” category of broker-dealer should not be required to file the compliance report. 76 The Commission has considered these comments but has determined not to provide for a broader exception from the requirement to file a compliance report for broker-dealers with limited custodial activities. The objectives of the compliance report and related examination of the compliance report are intended, among other things, to “increase the focus of independent public accountants on the custody practices of broker-dealers” and to “help identify broker-dealers that have weak controls for safeguarding investor assets.” 77 Therefore, broker-dealers that hold customer assets—even if their custodial activities are limited—generally should be subject to the requirement to file the compliance report and related accountant's report. 78 75 See, e.g., CAI Letter; CAI II Letter; McGladrey Letter. 76 See CAI II Letter. 77 See Broker-Dealer Reports, 76 FR at 37599. 78 Broker-dealers with extremely limited custodial activities ( e.g., holding customer checks made out to a third party for limited periods of time) could seek exemptive relief under section 36 of the Exchange Act (15 U.S.C. 77mm) from the requirement to file the compliance report and report of the independent public accountant covering the compliance report. The level of effort required by carrying broker-dealers to prepare a compliance report will depend on the nature and extent of their activities. For example, the controls of a carrying broker-dealer that engages in limited custodial activities could be less complex than the controls of a carrying broker-dealer that engages in more extensive custodial activities. 79 Therefore, this requirement is intended to be scalable so that a carrying broker-dealer with limited custodial activities generally should have to expend less effort to support its statements in the compliance report, particularly with respect to the statements relating to Rules 15c3-3 and 17a-13. 79 As discussed below in section II.D. of this release, the PCAOB has proposed attestation standards for an independent public accountant's examination of the compliance report and the review of the exemption report. The proposed examination standard provides procedural requirements for independent public accountants that are “designed to be scalable based on the broker's or dealer's size and complexity.” See Proposed Standards for Attestation Engagements Related to Broker and Dealer Compliance or Exemption Reports Required by the U.S. Securities and Exchange Commission and Related Amendments to PCAOB Standards, PCAOB Release No. 2011-004, PCAOB Rulemaking Docket Matter No. 035 (July 12, 2011) at 8 (“ PCAOB Proposing Release ”). The second key modification is that the final rule provides that the requirement to file the exemption report applies if the broker-dealer did claim that it was exempt from Rule 15c3-3 “throughout the most recent fiscal year.” 80 Thus, a broker-dealer that did not claim an exemption from Rule 15c3-3 at any time during the most recent fiscal year or claimed an exemption for only part of the fiscal year must file the compliance report. 81 80 See paragraphs (d)(1)(i)(B)( 1 )-( 2 ) of Rule 17a-5. 81 There will be cases where a broker-dealer changes its business model to convert from a carrying broker-dealer to a non-carrying broker-dealer during the fiscal year. In this case, the broker-dealer could seek exemptive relief under section 36 of the Exchange Act (15 U.S.C. 78mm) from the requirement to file the compliance report and to instead file the exemption report. In analyzing such a request, the period of time the broker-dealer operated as a carrying broker-dealer would be a relevant consideration. The third key modification is that the final rule specifies the individual who must execute the compliance reports and exemption reports. 82 As noted above, one commenter stated that the Commission should make clear who should sign the compliance reports and exemption reports and what liability attaches in the event of a misstatement or omission. 83 The commenter suggested a reasonableness standard, and stated that the Commission should make clear that the reports do not create a new private right of action. 84 In response to this comment, the final rule provides that the compliance report and the exemption report must be executed by the person who makes the oath or affirmation under paragraph (e)(2) of Rule 17a-5. 85 As discussed below in more detail in section II.C.2. of this release, paragraph (e)(2) of Rule 17a-5 requires an oath or affirmation to be attached to the financial report and provides that the oath or affirmation must be made by certain types of persons depending on the corporate form of the broker-dealer ( e.g., a duly authorized officer if the broker-dealer is a corporation). 86 The requirement to file these new reports with the Commission is not intended to establish a new private cause of action. 82 See paragraphs (d)(1)(i)(B)( 1 )-( 2 ) of Rule 17a-5. 83 See CAI Letter. The filings discussed above constitute a “report” for purposes of 15 U.S.C. 78ff(a) and other applicable provisions of the Exchange Act. As a consequence, it would be unlawful for a broker-dealer to willfully make or cause to be made, a false or misleading statement of a material fact or omit to state a material fact in the filings. 84 Id. 85 See paragraphs (d)(1)(i)(B)( 1 )-( 2 ) of Rule 17a-5. 86 See paragraph (e)(2) of Rule 17a-5. 2. The Financial Report—Paragraph (d)(2) of Rule 17a-5 Before today's amendments, paragraph (d)(2) of Rule 17a-5 required that the annual audited report of a broker-dealer contain certain financial statements in a format consistent with Form X-17A-5 Part II or Form X-17A-5 Part IIa, as applicable, including a statement of financial condition, an income statement, a statement of cash flows, a statement of changes in owners' equity, and a statement of changes in liabilities subordinated to claims of general creditors. 87 Paragraph (d)(3) of Rule 17a-5 required that the annual audited report contain supporting schedules, including a computation of net capital under Rule 15c3-1, a computation for determining reserve requirements under Rule 15c3-3, and information relating to the possession and control requirements of Rule 15c3-3. 88 Paragraph (d)(4) of Rule 17a-5 required a reconciliation between the net capital and reserve computations in the audited report and those in the most recent Form X-17A-5 Part II or Form X-17A-5 Part IIa, if there were material differences between the annual audited report and the form. 89 87 See 17 CFR 240.17a-5(d)(2). As noted above, Form X-17A-5 Part II and Form X-17A-5 Part IIa are among the FOCUS Reports that broker-dealers complete and file with the Commission or their DEA on a periodic basis. See 17 CFR 240.17a-5(a) and 17 CFR 249.617. These two forms require broker-dealers to file monthly or quarterly financial information with the Commission or their DEA, including information about the broker-dealer's: (1) Assets and liabilities; ownership equity; net capital computation under Rule 15c3-1; minimum net capital requirement under Rule 15c3-1; income (loss); computation of the customer reserve requirement under Rule 15c3-3 in the case of Form X-17A-5 Part II; the possession and control requirements under Rule 15c3-3 in the case of Form X-17A-5 Part II; and changes in ownership equity. 88 See 17 CFR 240.17a-5(d)(3). 89 See 17 CFR 240.17a-5(d)(4). The Commission proposed combining the provisions in paragraphs (d)(2) through (d)(4) of Rule 17a-5 in revised paragraph (d)(2) without substantive modification to those provisions. 90 In addition, the Commission proposed that revised paragraph (d)(2) be titled “Financial report” to reflect that the information required in this report would be financial in nature and to differentiate it from the proposed compliance reports and exemption reports. The Commission did not receive comments concerning the amendments to paragraph (d)(2) of Rule 17a-5 and is adopting them substantially as proposed. 91 90 See Broker-Dealer Reports, 76 FR at 37575. 91 See paragraph (d)(2) of Rule 17a-5. The Commission has made plain English changes to the language of the paragraph ( e.g., replacing the term “shall” with “must”). The Commission also, consistent with current practice, has clarified that the financial statements must be prepared in accordance with U.S. GAAP to distinguish from other accounting frameworks. See paragraph (d)(2) of Rule 17a-5. In addition, the Commission has replaced the words “notes to the consolidated statement of financial condition” with “notes to the financial statements.” This change in terminology is designed to conform the language in Rule 17a-5 to current accounting practice. Under GAAP, notes to a complete set of financial statements must cover all the financial statements, and not just one of the statements, such as the consolidated statement of financial condition. 3. The Compliance Report—Paragraph (d)(3) of Rule 17a-5 i. The Proposed Amendments As proposed, the requirements for the contents of the compliance report were prescribed in paragraph (d)(3) of Rule 17a-5. 92 Under the proposal, a carrying broker-dealer would need to include in the compliance report a specific statement, certain assertions, and descriptions. 93 The independent public accountant would examine the assertions in the compliance report in preparing the report of the accountant. 94 92 See Broker-Dealer Reports, 76 FR at 37575-37578. 93 Id. 94 Id. The independent public accountant would not have been required to examine the proposed “statement” and descriptions in the compliance report. Specifically, as proposed, the carrying broker-dealer would be required to include in the compliance report a statement as to whether the firm has established and maintained a system of internal control to provide the broker-dealer with reasonable assurance that any instances of material non-compliance with the financial responsibility rules will be prevented or detected on a timely basis. 95 In addition, the compliance report would need to include the following three assertions: (1) Whether the broker-dealer was in compliance in all material respects with the financial responsibility rules as of its fiscal year end; (2) whether the information used to assert compliance with the financial responsibility rules was derived from the books and records of the broker-dealer; and (3) whether internal control over compliance with the financial responsibility rules was effective during the most recent fiscal year such that there were no instances of material weakness. 96 Finally, the carrying broker-dealer would need to include in the compliance report a description of each identified instance of material non-compliance and each identified material weakness in internal control over compliance with the financial responsibility rules. 97 The independent public accountant would examine the assertions in preparing the report of the accountant. 98 The independent public accountant would not examine the statement regarding the establishment of the system of internal control. 95 See Broker-Dealer Reports, 76 FR at 37575-37576. 96 Id. 97 Id. 98 Id. GAAS and PCAOB standards for attestation engagements provide that accountants ordinarily should obtain written assertions in an examination or review engagement. See, e.g., PCAOB Interim Attestation Standard, AT Section 101 at ¶ .09. Accordingly, the Commission proposed that the independent public accountant's report cover only the three assertions in the compliance report. Under the proposal, the broker-dealer would not be able to assert compliance with the financial responsibility rules as of its most recent fiscal year end if it identified one or more instances of material non-compliance. 99 Similarly, the broker-dealer would not be able to assert that its internal control over compliance with the financial responsibility rules during the fiscal year was effective if one or more material weaknesses existed with respect to internal control over compliance. 100 99 See Broker-Dealer Reports, 76 FR at 37576-37577. 100 Id. at 37577. An instance of material non-compliance was proposed to be defined as a failure by the broker-dealer to comply with any of the requirements of the financial responsibility rules in all material respects. 101 When determining whether an instance of non-compliance is material, the Commission stated that the broker-dealer should consider all relevant factors including but not limited to: (1) The nature of the compliance requirements, which may or may not be quantifiable in monetary terms; (2) the nature and frequency of non-compliance identified; and (3) qualitative considerations. 102 The Commission also stated that some deficiencies would necessarily be instances of material non-compliance, including failing to maintain the required minimum amount of net capital under Rule 15c3-1 or failing to maintain the minimum deposit requirement in a special reserve bank account for the exclusive benefit of customers under Rule 15c3-3. 103 101 Id. 102 Id. 103 Id. The term material weakness was proposed to be defined as a deficiency, or a combination of deficiencies, in internal control over compliance with the financial responsibility rules, such that there is a reasonable possibility that material non-compliance with the financial responsibility rules will not be prevented or detected on a timely basis. 104 The proposed definition of material weakness was modeled on the definition of material weakness in a Commission rule—Rule 1-02(a)(4) of Regulation S-X 105 —and in auditing literature governing financial reporting. 106 In the proposing release, the Commission stated that a deficiency in internal control over compliance would exist when the design or operation of a control does not allow the broker-dealer, in the normal course of performing its assigned functions, to prevent or detect non-compliance with the financial responsibility rules on a timely basis. 107 The Commission also stated that, for purposes of the proposed definition of the term material weakness, there is a reasonable possibility of an event occurring if it is probable or reasonably possible. 108 The Commission further stated that an event is probable if the future event or events are likely to occur and that an event is reasonably possible if the chance of the future event or events occurring is more than remote, but less than likely. 109 104 Id. 105 See 17 CFR 210.1-02(a)(4); 17 CFR 240.12b-2. 106 See PCAOB Auditing Standard, AS No. 5 app. A at ¶ A7; American Institute of Certified Public Accountants (“AICPA”), AU Section 325 at ¶ .06. 107 See Broker-Dealer Reports, 76 FR at 37577. 108 Id. See also Commission Guidance Regarding Management's Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Securities Act of 1933 Release No. 8810 (June 20, 2007), 72 FR 35324, 35332 n.47 and corresponding text (June 27, 2007). 109 Broker-Dealer Reports, 76 FR at 37577. The Commission has stated in other contexts that there is a reasonable possibility of an event occurring if it is “probable” or “reasonably possible.” See Amendments to Rules Regarding Management's Report on Internal Control Over Financial Reporting, Exchange Act Release No. 55928 (June 20, 2007), 72 FR 35310 (June 27, 2007). See also 17 CFR 240.12b-2; 17 CFR 210.1-02. Commission guidance provides that an event is “probable” if the future event or events are likely to occur, and that an event is “reasonably possible” if the chance of the future event or events occurring is more than remote, but less than likely. See Commission Guidance Regarding Management's Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, 72 FR at 35332 n.47 and corresponding text. ii. Comments Received The Commission received a number of comments on the proposed compliance report. Generally, the comments focused on the intended scope of the compliance report and the assertions to be included. Specifically, many commenters raised concerns about what would constitute “material non-compliance.” 110 Several of these commenters urged the Commission to provide guidance with additional specific examples or quantitative and qualitative factors to be considered when determining whether non-compliance was material. 111 One commenter proposed alternate definitions for material non-compliance and material weakness and provided examples of non-compliance that should not be regarded as material. 112 110 See ABA Letter; CAI Letter; CAQ Letter; Deloitte Letter; E&Y Letter; Grant Thornton Letter; KPMG Letter; McGladrey Letter; PWC Letter; SIFMA Letter; Van Kampen/Invesco Letter. 111 See ABA Letter; CAQ Letter; E&Y Letter; KPMG Letter; McGladrey Letter; PWC Letter. 112 See SIFMA Letter. Commenters also addressed the time period covered by the assertion relating to effectiveness of internal control. In particular, some commenters stated that the proposed assertion that internal control was effective should be as of a point in time, as opposed to “during the fiscal year.” 113 One commenter stated that broker-dealers that must file the internal control report required under Rule 206(4)-2 should be able to elect to make the assertion pertain to the entire fiscal year in order to satisfy reporting requirements under the IA Custody Rule. 114 Others stated that broker-dealers should have the opportunity to remediate any material weaknesses in internal control that were identified during the period and, if corrective action was taken, not be required to include them in the compliance report. 115 113 See Deloitte Letter; E&Y Letter; Grant Thornton Letter; KPMG Letter. 114 See E&Y Letter. This commenter also stated that a point-in-time assessment would be consistent with the requirement for issuers subject to internal control reporting under section 404 of the Sarbanes-Oxley Act. Further, for carrying broker-dealers that are not subject to Rule 206(4)-2, this commenter stated that the incremental benefits of having the assertion pertain to the entire year rather than the year end assessment does not justify the cost. Id. 115 See CAQ Letter; Deloitte Letter; McGladrey Letter. Regarding the proposed assertion that the broker-dealer was in compliance with the financial responsibility rules, one commenter stated that broker-dealers may need to interpret certain requirements and in other cases broker-dealers may be relying on informal interpretations obtained through dialogue with the Commission or its DEA. 116 This commenter recommended that in those circumstances the Commission require broker-dealers to formally document such interpretations and obtain evidence of agreements reached with the Commission or the DEA. Some commenters stated that the Commission should provide additional guidance about the control objectives that would need to be met to achieve effective internal control over compliance with the financial responsibility rules. 117 Several commenters urged the Commission to clarify the interaction between material weaknesses in internal control over financial reporting and material weaknesses in internal control over compliance with the financial responsibility rules. 118 One commenter stated that the compliance report was over-inclusive and burdensome, and suggested that the final rule focus instead on “issues most vital to the financial condition of the broker-dealer and its compliance and internal control over compliance.” 119 116 See E&Y Letter. 117 See Angel Letter; Deloitte Letter. 118 See Deloitte Letter; KPMG Letter; PWC Letter. 119 See CAI Letter. Some commenters had questions and comments about the proposed assertion that information used to assert compliance with the financial responsibility rules was derived from the books and records of the broker-dealer. Three commenters asked whether “books and records” means records maintained under Rule 17a-3. 120 120 See CAQ Letter; Deloitte Letter; E&Y Letter. iii. The Final Rule The Commission is adopting the proposed amendments to Rule 17a-5 requiring a carrying broker-dealer to prepare and file a compliance report, with modifications, some of which are in response to comments. 121 Generally, as adopted, the broker-dealer's compliance report will include five specific statements, and two descriptions, if applicable. 121 See paragraph (d)(3) of Rule 17a-5. Specifically, paragraph (d)(3) of Rule 17a-5 requires that the compliance report contain statements as to whether: (1) The broker-dealer has established and maintained Internal Control Over Compliance (which, as discussed below, is a defined term in the final rule); (2) the Internal Control Over Compliance of the broker-dealer was effective during the most recent fiscal year; (3) the Internal Control Over Compliance of the broker-dealer was effective as of the end of the most recent fiscal year; (4) the broker-dealer was in compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3 as of the end of the most recent fiscal year; and (5) the information the broker-dealer used to state whether it was in compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3 was derived from the books and records of the broker-dealer. Further, if applicable, the compliance report must contain a description of: (1) Each identified material weakness in the Internal Control Over Compliance during the most recent fiscal year, including those that were identified as of the end of the fiscal year; and (2) any instance of non-compliance with Rule 15c3-1 or paragraph (e) of Rule 15c3-3 as of the end of the most recent fiscal year. The final rule does not use the term assertion—the assertions contained in the proposal are now referred to as statements. 122 The consistent use of the term statements is designed to simplify the structure of the rule rather than to substantively change the nature of the matters stated in the compliance report or which of the statements are to be examined by the independent public accountant. 122 See paragraphs (d)(3)(i)(A)( 1 )-( 5 ) of Rule 17a-5. In the final rule, the first statement in the compliance report is whether the broker-dealer has established and maintained Internal Control Over Compliance. 123 The rule defines Internal Control Over Compliance to mean internal controls that have the objective of providing the broker-dealer with reasonable assurance that non-compliance with the financial responsibility rules will be prevented or detected on a timely basis. 124 In order to clarify the application of the rule, the proposal has been modified so that part of the statement contained in the proposed compliance report, as to the broker-dealer's system of internal control, has been incorporated in the definition of Internal Control Over Compliance in the final rule. 125 Under the final rule, a broker-dealer cannot state that it has established and maintained Internal Control Over Compliance if the internal controls do not provide the broker-dealer with reasonable assurance that non-compliance with the financial responsibility rules will be prevented or detected on a timely basis. 123 See paragraph (d)(3)(i)(A)( 1 ) of Rule 17a-5. 124 See paragraph (d)(3)(ii) of Rule 17a-5. 125 Id. The final rule also provides that a broker-dealer is not permitted to conclude that its Internal Control Over Compliance was effective if there were one or more material weaknesses in its Internal Control Over Compliance. 126 A material weakness is defined as a deficiency, or a combination of deficiencies, in the broker-dealer's Internal Control Over Compliance such that there is a reasonable possibility 127 that non-compliance with Rule 15c3-1 or paragraph (e) of Rule 15c3-3 will not be prevented or detected on a timely basis, or that non-compliance to a material extent with Rule 15c3-3, except for paragraph (e), Rule 17a-13 or any Account Statement Rule will not be prevented or detected on a timely basis. 128 A deficiency in Internal Control Over Compliance exists when the design or operation of a control does not allow the management or employees of the broker-dealer to prevent or detect on a timely basis non-compliance with the financial responsibility rules in the normal course of performing their assigned functions. 126 See paragraph (d)(3)(iii) of Rule 17a-5. See also 17 CFR 229.308(a)(3) (providing that “[m]anagement is not permitted to conclude that the registrant's internal control over financial reporting is effective if there are one or more material weaknesses in the registrant's internal control over financial reporting.”). 127 As noted above, the Commission has stated in other contexts that there is a reasonable possibility of an event occurring if it is “probable” or “reasonably possible.” See Amendments to Rules Regarding Management's Report on Internal Control Over Financial Reporting, 72 FR 35310. See also 17 CFR 240.12b-2; 17 CFR 210.1-02. Commission guidance provides that an event is “probable” if the future event or events are likely to occur, and that an event is “reasonably possible” if the chance of the future event or events occurring is more than remote, but less than likely. See Commission Guidance Regarding Management's Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, 72 FR at 35332 n.47 and corresponding text. 128 See paragraph (d)(3)(iii) of Rule 17a-5. See also 17 CFR 240.12b-2; 17 CFR 210.1-02(a)(4) (providing that a “[m]aterial weakness means a deficiency, or a combination of deficiencies, in internal controls over financial reporting . . . such that there is a reasonable possibility that a material misstatement of the registrant's annual or interim financial statements will not be prevented or detected on a timely basis.”). The final amendments reflect several other key changes from the proposal. For example, one commenter stated that the compliance report was overinclusive and burdensome, and therefore suggested that the final rule focus on “issues most vital to the financial condition of the broker-dealer and its compliance and internal control over compliance.” 129 The final rule requires a statement as to whether the broker-dealer was in compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3 as of the end of the most recent fiscal year and, if applicable, a description of any instances of non-compliance with these rules as of the fiscal year end. This is a modification from the proposed assertion that the broker-dealer is in compliance with the financial responsibility rules in all material respects and proposed description of any material non-compliance with the financial responsibility rules. Thus, the final rule reflects two changes from the proposal: (1) Elimination of the concepts of “material non-compliance” and “compliance in all material respects” for the purposes of reporting in the compliance report; and (2) a narrowing of these statements and requirements from compliance with all of the financial responsibility rules to compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3. In this way, the final rule more narrowly focuses on the core requirements of the financial responsibility rules, as suggested by the commenter. 129 See CAI Letter. The “material non-compliance” and “compliance in all material respects” concepts were designed to limit the types of instances of non-compliance that would prevent a carrying broker-dealer from stating that it was in compliance with the financial responsibility rules. In order to retain a limiting principle, the final rule focuses on provisions that trigger notification requirements when they are not complied with, namely, Rule 15c3-1 and the customer reserve requirement in paragraph (e) of Rule 15c3-3. 130 Any instance of non-compliance with these requirements as of the fiscal year end must be addressed in the compliance report. As stated in the proposing release, failing to maintain the required minimum amount of net capital under Rule 15c3-1 or failing to maintain the minimum deposit requirement in a special reserve bank account under paragraph (e) of Rule 15c3-3 would have been instances of material non-compliance under the proposed rule. 131 Accordingly, under the proposal, a broker-dealer would have been required to describe all instances of non-compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3. Under the proposal, a broker-dealer also would have been required to describe instances of material non-compliance with Rule 17a-13 and the Account Statement Rules. The final rule is narrower in that a broker-dealer is only required to describe instances of non-compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3. 130 See 17 CFR 240.15c3-1(a)(6)(iv)(B), (a)(6)(v), (a)(7)(ii), (a)(7)(iii), (c)(2)(x)(B)( 1 ), (c)(2)(x)(F)( 3 ) (notification requirements with respect to Rule 15c3-1); 17 CFR 240.17a-11(b)-(c) (notification requirements with respect to Rule 15c3-1); 17 CFR 240.15c3-3(i) (notification requirement in the event of a failure to make a required deposit to the reserve account). 131 See Broker-Dealer Reports, 76 FR at 37577. Consistent with these changes, the final rule requires a statement as to whether the carrying broker-dealer has established and maintained Internal Control Over Compliance, which is defined as internal controls that have the objective of providing the broker-dealer with reasonable assurance that non-compliance with the financial responsibility rules will be prevented or detected on a timely basis. 132 The definition of Internal Control Over Compliance modifies the proposed statement that the carrying broker-dealer has established and maintained a system of internal control to provide the firm with reasonable assurance that any instances of material non-compliance with the financial responsibility rules will be prevented or detected on a timely basis. 133 Thus, the definition eliminates the concept of material non-compliance. Similarly, the proposed assertion as to whether the information used to assert compliance with the financial responsibility rules was derived from the books and records of the carrying broker-dealer has been modified to a statement as to whether the information used to state whether the carrying broker-dealer was in compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3 was derived from the broker-dealer's books and records. 134 132 See paragraphs (d)(3)(i)(A)( 1 ) and (d)(3)(ii) of Rule 17a-5. As indicated above, the independent public accountant is not required to examine this statement. See paragraph (g)(2)(i) of Rule 17a-5. 133 See paragraphs (d)(3)(i)(A)( 1 ) and (d)(3)(ii) of Rule 17a-5. 134 See paragraph (d)(3)(i)(A)( 5 ) of Rule 17a-5. The definition of material weakness similarly has been modified from the proposal. Under the final rule, a material weakness would include deficiencies in internal control relating to “non-compliance” with Rule 15c3-1 or paragraph (e) of Rule 15c3-3, and “non-compliance to a material extent” with Rule 15c3-3, except for paragraph (e), Rule 17a-13, and the Account Statement Rules. 135 This modification of the definition of material weakness is based on the practical difficulties in creating a system of control that will eliminate a reasonable possibility of the occurrence of any instances of non-compliance with certain requirements of the financial responsibility rules. For example, the inadvertent failure to send one account statement out of thousands of such statements would not constitute non-compliance to a material extent with the Account Statement Rules though it would be an instance of non-compliance. 135 See paragraph (d)(3)(iii) of Rule 17a-5. Further, and consistent with current auditing standards, the definition of “deficiency in internal control” in the final rule has been modified to include the phrase “the management or employees of the broker or dealer” in place of the phrase “the broker or dealer.” 136 136 Id. See also PCAOB Auditing Standard, AS No. 5 app. A, at ¶ A3 (providing that “[a] deficiency in internal control over financial reporting exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.”). The final rule—substantially as proposed—requires the carrying broker-dealer to state whether its Internal Control Over Compliance was effective during the most recent fiscal year. 137 Some commenters suggested that a broker-dealer that has remediated a material weakness be permitted to provide an assertion about whether a material weakness still exists at the end of the year, instead of having to state whether internal control was effective during the most recent fiscal year. 138 In light of the importance of a broker-dealer being in continual compliance with the financial responsibility rules, the Commission believes it is appropriate for the broker-dealer's statement to address effectiveness of its Internal Control Over Compliance throughout the fiscal year. Consequently, the final rule requires the statement to cover the entire fiscal year as opposed to the date that is the end of the fiscal year as suggested by commenters. 137 See paragraph (d)(3)(i)(A)( 2 ) of Rule 17a-5. 138 See CAQ Letter; E&Y Letter; KPMG Letter; PWC Letter. However, in response to comments suggesting that the broker-dealer be permitted to report the remediation or whether a material weakness still exists at the end of the year, 139 the final rule also requires the carrying broker-dealer to state whether its Internal Control Over Compliance was effective as of the end of the most recent fiscal year. 140 Thus, if there was a material weakness in the Internal Control Over Compliance of the broker-dealer during the year that has been addressed such that the broker-dealer no longer considers there to be a material weakness at fiscal year end, the compliance report would reflect both the identification of the material weakness and that its Internal Control Over Compliance was effective as of the end of the most recent fiscal year, thereby indicating that the material weakness had been addressed as of the fiscal year end. 139 See CAQ Letter; Deloitte Letter; E&Y Letter; McGladrey Letter. 140 See paragraph (d)(3)(i)(A)( 3 ) of Rule 17a-5. Consistent with these changes, the final rule provides that the carrying broker-dealer cannot conclude that its Internal Control Over Compliance was effective during the most recent fiscal year if there were one or more material weaknesses in Internal Control Over Compliance of the broker-dealer during the fiscal year. 141 The final rule adds a similar provision relating to the effectiveness of a broker-dealer's Internal Control Over Compliance at the end of the most recent fiscal year 142 to respond to comments 143 and to align with the additional statement discussed above as to whether the broker-dealer's Internal Control Over Compliance was effective as of the end of the fiscal year. 144 141 See paragraph (d)(3)(iii) of Rule 17a-5. See also 17 CFR 229.308(a)(3) (providing that “[m]anagement is not permitted to conclude that the registrant's internal control over financial reporting is effective if there are one or more material weaknesses in the registrant's internal control over financial reporting.”). 142 See paragraph (d)(3)(iii) of Rule 17a-5. 143 See CAQ Letter; Deloitte Letter; E&Y Letter; McGladrey Letter. 144 See paragraph (d)(3)(i)(A)( 3 ) of Rule 17a-5. The final rule also retains the proposed requirement that the carrying broker-dealer provide a description of each identified material weakness in the broker-dealer's Internal Control Over Compliance, but, in conformity with other modifications to the proposal, the final rule requires that the material weaknesses include those identified during the most recent fiscal year as well as those that were identified as of the end of the fiscal year. 145 This change should not add a significant burden because broker-dealers should know whether any material weaknesses identified before year end have been remediated. 145 See paragraph (d)(3)(i)(B) of Rule 17a-5. As noted above, one commenter recommended that the Commission require broker-dealers to document oral guidance obtained through dialogue with Commission or DEA staff. 146 While such a requirement was not proposed and is not being adopted in the final rule, it may be appropriate and prudent for a broker-dealer to maintain documentation in its books and records of the matters discussed with the Commission or DEA staff, the broker-dealer's own views and conclusion on those matters, and any guidance received by the broker-dealer. 146 See E&Y Letter. Also as noted above, two commenters asked the Commission to provide additional guidance about the control objectives that should be met to achieve effective internal control over compliance with the financial responsibility rules. 147 As stated in the proposing release, the control objectives identified in the Commission's guidance on Rule 206(4)-2 are more general than the specific operational requirements in the financial responsibility rules. 148 In particular, broker-dealers are subject to operational requirements with respect to handling and accounting for customer assets. 149 Given the specificity of the financial responsibility rules, the Commission does not believe that additional guidance about the control objectives is necessary. 147 See Angel Letter; Deloitte Letter. 148 See Broker-Dealer Reports, 76 FR at 37580. 149 Id. As noted above, several commenters sought assurances that the independent public accountant's examination of the compliance report would not cover the effectiveness of internal control over financial reporting. 150 The final rule does not require that the broker-dealer include a statement regarding the effectiveness of its internal control over financial reporting, nor does it require that the independent public accountant attest to the effectiveness of internal control over financial reporting. The requirement in the final rule is for the broker-dealer to state whether its Internal Control Over Compliance was effective during the most recent fiscal year and at the end of the fiscal year and for the accountant to express an opinion based on an examination of those statements. 150 See Deloitte Letter; KPMG Letter; PWC Letter. A broker-dealer's Internal Control Over Compliance is intended to focus, for example, on a broker-dealer's oversight of custody arrangements and protection of customer assets. In contrast, internal control over financial reporting is focused on the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. As stated in the proposing release, the Commission did not propose that effectiveness of internal control over financial reporting be included as one of the assertions made by the broker-dealer in the compliance report. The Commission intends that the compliance report should focus on oversight of net capital, custody arrangements, and protection of customer assets, and therefore, should be focused on compliance with the financial responsibility rules. Further, the examination of the compliance report would pertain solely to certain statements in the compliance report and not to the broker-dealer's process for arriving at the statements. The report of the independent public accountant, based on the examination of the compliance report, requires the accountant to perform its own independent examination of the related internal controls. Consequently, it is not necessary for the independent public accountant to provide an opinion with regard to the process that the broker-dealer used to arrive at its conclusions. As noted above, commenters sought clarification of the meaning of “books and records” as used in the compliance report statement. The reference in paragraph (d)(3)(i)(A)( 5 ) of Rule 17a-5 to books and records refers to the books and records a broker-dealer is required to make and maintain under Commission rules ( e.g., Rule 17a-3 and Rule 17a-4). 151 151 See 17 CFR 240.17a-3; 17 CFR 240.17a-4. 4. The Exemption Report—Paragraph (d)(4) of Rule 17a-5 i. Proposed Amendments The Commission proposed that the exemption report must contain an assertion by the broker-dealer that it is exempt from Rule 15c3-3 because it meets conditions set forth in paragraph (k) of Rule 15c3-3 and “should identify the specific conditions.” 152 As discussed below in section II.D.3. of this release, under the proposal, the independent public accountant, as part of the engagement, would have been required to prepare a report based on a review of the exemption report in accordance with PCAOB standards. 153 152 See Broker-Dealer Reports, 76 FR at 37580-37581. 153 Id. at 37578-37579. PCAOB standards for attestation engagements provide that accountants ordinarily should obtain written assertions in an examination or review engagement. ii. Comments Received The Commission received several comments regarding the exemption report. 154 Some commenters stated that the Commission should clarify whether the assertion would cover the entire fiscal year or be as of a fixed date. 155 One commenter stated that the assertion should be as of a fixed date. 156 With respect to the independent public accountant's review of the exemption report, one commenter provided the example of a bank or clerical error that results in a broker-dealer that operates under an exemption to Rule 15c3-3 finding itself in possession of customer assets overnight once during the fiscal year. 157 This commenter stated that such a situation should not “warrant the `material modification' of a broker-dealer's Exemption Report.” 158 Similarly, another commenter noted that “to consider a single instance of a broker-dealer failing to promptly forward a customer's securities as an instance that would necessitate a material modification creates an unworkable standard.” 159 154 See CAQ Letter; Deloitte Letter; Grant Thornton Letter; KPMG Letter. Some of the comments relating to the exemption report and the response to the comments are discussed above in section II.B.1. of this release. 155 See CAQ Letter; Deloitte Letter; Grant Thornton Letter; KPMG Letter. 156 See KPMG Letter. 157 See SIFMA Letter. 158 Id. 159 See CAI Letter. One commenter stated that the exemption report relates only to Rule 15c3-3 and asked how the Commission intended to assess, for a firm that claims an exemption from Rule 15c3-3, compliance with Rule 15c3-1 and the adequacy of the firm's internal control over compliance with that rule. 160 Another commenter asked whether the exemption report should be replaced with a box to check on the FOCUS Report, as the amount of paperwork involved for small firms “seems rather excessive.” 161 160 See McGladrey Letter. 161 See Angel Letter. iii. The Final Rule The Commission is adopting, with modifications discussed below, the requirements regarding the exemption report. 162 The modifications are designed to address commenters' concerns that the proposed exemption report assertion would create an unworkable standard given the possibility that a broker-dealer might have instances of exceptions to meeting the exemption provisions in paragraph (k) of Rule 15c3-3 and that the proposed requirements with respect to the exemption report did not explicitly provide how exceptions should be treated. In response to these concerns, the final rule provides that exemption reports must contain the following statements made to the best knowledge and belief of the broker-dealer: (1) A statement that identifies the provisions in paragraph (k) of Rule 15c3-3 under which the broker-dealer claimed an exemption from Rule 15c3-3; (2) a statement the broker-dealer met the identified exemption provisions in paragraph (k) of Rule 15c3-3 throughout the most recent fiscal year without exception or that it met the identified exemption provisions in paragraph (k) of Rule 15c3-3 throughout the most recent fiscal year except as described in the exemption report; and (3) if applicable, a statement that identifies each exception during the most recent fiscal year in meeting the identified provisions in paragraph (k) of Rule 15c3-3 and that briefly describes the nature of each exception and the approximate date(s) on which the exception existed. 163 162 See paragraph (d)(4) of Rule 17a-5. 163 Id. In response to comments seeking clarity as to whether the assertion in the exemption report should cover a fixed date or the fiscal year, 164 the final rule explicitly provides that the statement and certain information in the exemption report must cover the most recent fiscal year. 165 This corresponds to the provisions of paragraph (d)(1)(i)(B) of Rule 17a-5 governing when a broker-dealer must file the exemption report instead of the compliance report. In particular, a broker-dealer that claimed an exemption from Rule 15c3-3 throughout the most recent fiscal year must file the exemption report. 166 164 See CAQ Letter; Deloitte Letter; Grant Thornton Letter; KPMG Letter. 165 See paragraph (d)(4)(ii) of Rule 17a-5. 166 See paragraph (d)(1)(i)(B) of Rule 17a-5. In addition, as proposed, the exemption report was required to contain an assertion that the broker-dealer “is exempt from the provisions” of Rule 15c3-3 “because it meets conditions set forth in” paragraph (k) of Rule 15c3-3 and “should identify the specific conditions.” 167 Thus, the exemption report would have required the broker-dealer to state definitively that “it is exempt” from Rule 15c3-3 because it “meets the conditions set forth in” in paragraph (k). 168 As noted above, commenters raised questions and concerns about how certain exceptions would be handled under the proposed exemption report requirements. The final rule addresses these comments in a number of ways. 167 See Broker-Dealer Reports, 76 FR at 37604. 168 Id. First, it provides that the statements in the exemption report must be made to the “best knowledge and belief of the broker or dealer.” 169 This modification is designed to address situations where the broker-dealer is unaware of an instance or instances in which it had an exception to meeting the exemption provisions in paragraph (k) of Rule 15c3-3 during the most recent fiscal year. As discussed below, the broker-dealer must state in the report that it met the exemption provisions throughout the year without exceptions or with exceptions that must be identified. 170 169 See paragraph (d)(4) of Rule 17a-5. 170 As discussed above in section II.B.3. of this release, a carrying broker-dealer must state in the compliance report whether it was in compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3 as of the end of the most recent fiscal year. See paragraph (d)(3)(i)(A)( 4 ) of Rule 17a-5. In response to comments and in light of the nature of the statements required in the exemption report, the Commission added the best knowledge and belief standard to the exemption report requirement. Second, the final rule provides that the broker-dealer first must identify in the exemption report the “provisions” in paragraph (k) of Rule 15c3-3 under which it “claimed” an exemption from Rule 15c3-3. 171 As discussed above in section II.B.1. of this release, the final rule has been modified to provide that a broker-dealer must file the exemption report if it did “claim that it was exempt” from Rule 15c3-3 throughout the most recent fiscal year. 172 This change is designed to remove any ambiguity as to when a broker-dealer must file the exemption report as opposed to the compliance report, particularly in situations where the broker-dealer had exceptions to meeting the exemption provisions in paragraph (k) of Rule 15c3-3. Consistent with this change, the final rule requires the broker-dealer to identify in the exemption report the provisions in paragraph (k) under which it “claimed the exemption.” 173 171 See paragraph (d)(4)(i) of Rule 17a-5. As proposed, paragraph (d)(4) of Rule 17a-5 provided that the exemption report “shall contain a statement by the broker or dealer that it is exempt from the provisions of [Rule 15c3-3] because it meets the conditions set forth in [paragraph (k) of Rule 15c3-3] and should identify the specific conditions.” See Broker-Dealer Reports, 76 FR 37604 (emphasis added). The Commission intended that the broker-dealer be required to identify the provisions of paragraph (k) of Rule 15c3-3 under which the broker-dealer was claiming the exemption. To make clear that this requirement and the other requirements of the exemption report are mandatory, the final rule uses the word “must” in relation to each element of the exemption report. See paragraph (d)(4) of Rule 17a-5. 172 See paragraph (d)(1)(i)(B)( 2 ) of Rule 17a-5. A broker-dealer claiming an exemption from Rule 15c3-3 is required to indicate the basis for the exemption on the periodic reports it files with securities regulators. See, e.g., Item 24 of Part IIa of the FOCUS Reports. See 17 CFR 249.617. 173 See paragraph (d)(4)(i) of Rule 17a-5. Further, as proposed, the broker-dealer would have been required to identify the exemption “conditions” in paragraph (k) of Rule 15c3-3. 174 The use of the word “provisions” in the final rule is designed to eliminate a potential ambiguity as to whether the exemption provisions in paragraphs (k)(2) and (3) of Rule 15c3-3 applied to the exemption report. In particular, paragraph (k) of Rule 15c3-3 prescribes “exemptions” from the requirements of Rule 15c3-3. 175 Paragraph (k)(1) provides that the requirements of Rule 15c3-3 do not apply to a broker-dealer that meets all of the “conditions” set forth in the paragraph. 176 Paragraph (k)(2) identifies two sets of conditions (without using the word “conditions”) either of which exempts a broker-dealer from the requirements of Rule 15c3-3. 177 Paragraph (k)(3) provides that the Commission may exempt a broker-dealer from the provisions of Rule 15c3-3, either unconditionally or on specified terms and conditions, if the Commission finds that the broker-dealer has established safeguards for the protection of funds and securities of customers comparable with those provided for by Rule 15c3-3 and that it is not necessary in the public interest or for the protection of investors to subject the particular broker-dealer to the provisions of Rule 15c3-3. 178 The Commission intended that a broker-dealer file an exemption report if it is exempt from Rule 15c3-3 under the provisions in either paragraph (k)(1), (k)(2)(i), (k)(2)(ii), or (k)(3) of Rule 15c3-3. To make this clear, the final rule refers to the “provisions” of paragraph (k) of Rule 15c3-3. 179 Consequently, a broker-dealer filing the exemption report must identify the provisions in paragraph (k) that it relied on to claim an exemption from Rule 15c3-3. 180 174 See paragraph (d)(4)(ii) of Rule 17a-5. The proposed rule provided that the broker-dealer must assert that it is exempt from the provisions of Rule 15c3-3 because it meets “conditions” set forth in paragraph (k) and should identify the specific “conditions.” See Broker-Dealer Reports, 76 FR at 37580-37581. 175 See 17 CFR 240.15c3-3(k)(1), (k)(2)(i), (k)(2)(ii), and (k)(3). 176 See 17 CFR 240.15c3-3(k)(1)(i)-(iv). 177 See 17 CFR 240.15c3-3(k)(2)(i)-(ii). 178 See 17 CFR 240.15c3-3(k)(3). 179 This modification is consistent with Item 24 of Part IIa of the FOCUS Report, which is titled “EXEMPTIVE PROVISION UNDER RULE 15c3-3” and requires a broker-dealer that claims to be exempt from the requirements of Rule 15c3-3 to identify the provision in Rule 15c3-3—paragraph (k)(1), paragraph (k)(2)(i), paragraph (k)(2)(ii), or paragraph (k)(3)—under which it is claiming to be exempt. See 17 CFR 249.617. 180 This change also is intended to make clear that the broker-dealer can identify the provisions of paragraph (k) of Rule 15c3-3 that the broker-dealer is relying on to claim the exemption by simply identifying in the exemption report the subparagraph in paragraph (k) ( i.e., (k)(1), (k)(2)(i), (k)(2)(ii), or (k)(3)) that contains the particular conditions the broker-dealer is relying on to claim the exemption rather than repeating the conditions themselves in the exemption report. For example, it would be sufficient for a broker-dealer relying on the exemption provisions in paragraph (k)(2)(ii) of Rule 15c3-3 to identify the provisions in the exemption report under which in claimed an exemption by referring to “paragraph (k)(2)(ii) of Rule 15c3-3” or “17 CFR 240.15c3-3(k)(2)(ii).” The third modification designed to address commenters' questions and concerns about how to handle exceptions to meeting the exemption provisions in paragraph (k) of Rule 15c3-3 relates to the proposed assertion that the broker-dealer “is exempt from the provisions” of Rule 15c3-3 “because it meets conditions set forth in” paragraph (k). The final rule provides that the exemption report must contain a statement that the broker-dealer met the identified exemption provisions in paragraph (k) of Rule 15c3-3 throughout the most recent fiscal year without exception or that it met the identified exemption provisions in paragraph (k) of Rule 15c3-3 throughout the most recent fiscal year except as described in the exemption report. 181 This modification from requiring the broker-dealer to state an absolute ( i.e., that it is exempt from Rule 15c3-3) allows the broker-dealer to account for instances in which it had exceptions to meeting the exemption provisions in paragraph (k) of Rule 15c3-3 directly in the exemption report (rather than having to file the compliance report). Specifically, if to the broker-dealer's best knowledge and belief, it had no exceptions during the most recent fiscal year to the identified exemption provisions in paragraph (k) of Rule 15c3-3, it must state in the exemption report that it met the identified exemption provisions in paragraph (k) without exception. Alternatively, a broker-dealer that had exceptions must state that it met the identified exemption provisions except as described in the exemption report. 181 See paragraph (d)(4)(ii) of Rule 17a-5. If the broker-dealer states that it had exceptions ( e.g., exceptions identified during the year, such as through routine monitoring of its compliance processes as part of the execution of its internal controls, internal or external audits, or regulatory examinations), the final rule requires the firm to identify, to its best knowledge and belief, each exception and briefly describe the nature of the exception and the approximate date(s) on which the exception existed. 182 The Commission expects that non-carrying broker-dealers generally track exceptions as part of monitoring compliance with the exemption provisions in paragraph (k) of Rule 15c3-3. 183 Further, a non-carrying broker-dealer's adherence to the exemption provisions in paragraph (k) of Rule 15c3-3 generally is a focus of Commission examiners when they conduct financial responsibility examinations on this class of firm. For example, examiners will review whether a non-carrying broker-dealer promptly forwards checks in accordance with provisions in paragraph (k) of Rule 15c3-3. The Commission also notes that the 2011 AICPA Broker Dealer Audit Guide states: “In auditing the financial statements of a broker-dealer claiming exemption from SEC Rule 15c3-3, the auditor should determine whether and to what extent the broker-dealer complied with the specific exemption during the audit period as well as the quality of the broker-dealer's controls and procedures to ensure ongoing compliance.” 184 In addition, under the PCAOB's proposed standards, the independent public accountant should inquire of individuals at the broker-dealer who have relevant knowledge of controls relevant to the broker-dealer's compliance with the exemption provisions and who are responsible for monitoring compliance with the exemption provisions whether they are aware of any deficiencies in controls over compliance or instances of non-compliance with the exemption conditions. 185 Moreover, in the independent public accountant's report, “[i]f the broker's or dealer's statement is not fairly stated, in all material respects, because of an instance or certain instances of non-compliance with the exemption conditions, the auditor must modify the review report to describe those instances of non-compliance and state that the broker or dealer is not in compliance with the specified exemption conditions.” 186 182 See paragraph (d)(4)(iii) of Rule 15c3-3. 183 See, e.g., Net Capital Rule, Exchange Act Release No. 31511 (Nov. 24, 1992), 57 FR 56973 (Dec. 2, 1992), at 56981 n.25 (stating that non-carrying broker-dealers must develop procedures to ensure that they do not receive customer securities or checks made payable to themselves). 184 See AICPA Broker-Dealer Audit Guide at ¶ 3.35. 185 See PCAOB Proposing Release app. 2 at ¶ 10. 186 Id. at ¶ 20. Under the final rule, a non-carrying broker-dealer must identify in the exemption report and describe each exception during the most recent fiscal year in meeting the identified exemption provisions in paragraph (k) of Rule 15c3-3. The description must include the approximate date(s) on which the exception existed. Without such reporting, the Commission and the broker-dealer's DEA would have no information to assess the nature, extent, and significance of the exceptions. As noted above, one commenter asked whether the exemption report should be replaced with a box to check on the FOCUS Report, as the amount of paperwork involved for small firms “seems rather excessive.” 187 The Commission does not believe this is an appropriate alternative. First, as indicated above, a broker-dealer claiming an exemption from Rule 15c3-3 already is required to indicate the basis for the exemption on its FOCUS Report. 188 Second, the exemption report requires the broker-dealer to make certain statements that the independent public accountant must review. Thus, the exemption report will provide a standardized statement across all broker-dealers claiming an exemption from Rule 15c3-3 for the independent public accountant to review. Third, the exemption report will provide the Commission and the broker-dealer's DEA with more information than currently is reported by non-carrying broker-dealers in the FOCUS Report. Specifically, it requires the broker-dealer to, among other things, state either that it met the identified exemption provisions in paragraph (k) throughout the most recent fiscal year without exception or that it met the identified exemption provisions throughout the most recent fiscal year except as described in the report. This will provide the Commission and the broker-dealer's DEA with information as to whether a broker-dealer is meeting the exemption provisions of paragraph (k) of Rule 15c3-3 (not simply that the broker-dealer is claiming the exemption as is reported in the FOCUS Report). Fourth, requiring that the exemption report be filed with the Commission should increase broker-dealers' focus on the statements being made, facilitating consistent compliance with the exemption provisions in Rule 15c3-3, and therefore, providing better protection of customer assets. Fifth, the requirement to prepare and file the exemption report should not result in excessive paperwork, as stated by one commenter. 189 187 See Angel Letter. 188 See Item 24 of Part IIa of the FOCUS Report. 189 See Angel Letter. The commenter did not explain why the exemption report would result in excessive paperwork. Id. See also discussion below in section VI.D.1.iii. of this release for the estimated paperwork hour burden associated with this requirement. As noted above, one commenter pointed out that the exemption report relates solely to Rule 15c3-3 and asked how the adequacy of a non-carrying broker-dealer's internal controls over compliance with Rule 15c3-1 would be assessed. 190 Under the final amendments, a broker-dealer's financial report will continue to include a supporting schedule containing a net capital computation under Rule 15c3-1, which will be covered by the independent public accountant's examination of the financial report. Moreover, the PCAOB has proposed standards for auditing supplemental information accompanying audited financial statements. 191 190 See McGladery Letter. The material inadequacy report—which applied to carrying and non-carrying broker-dealers—covered Rule 15c3-1. See 17 CFR 240.17a-5(g). 191 See Proposed Auditing Standard, Auditing Supplemental Information Accompanying Audited Financial Statements and Related Amendments to PCAOB Standards, PCAOB Release No. 2011-05, PCAOB Rulemaking Docket Matter No. 036 (July 12, 2011) (“ PCAOB Proposed Auditing Standard for Supplemental Information” ). 5. Time for Filing Annual Reports—Paragraph (d)(5) of Rule 17a-5 Prior to today's amendments, paragraph (d)(5) of Rule 17a-5 required that the annual audit report be filed not more than 60 days after the date of the financial statements. 192 The Commission proposed amending paragraph (d)(5) to replace the term annual audit report with annual reports . 193 This change was designed to reflect the fact that, under the proposal, broker-dealers must file a financial report, a compliance report or exemption report, and reports prepared by an independent public accountant covering these reports. While the Commission did not receive comments on this proposed change, one commenter stated that the existing requirement in Rule 17a-5 that the annual audit report be filed 60 days after the date of the financial statements should be lengthened to 90 days. 194 In support of this recommendation, the commenter cited CFTC Rule 1.10, which allows an FCM up to 90 days to file annual audit reports. 195 192 See 17 CFR 240.17a-5(d)(5). 193 See Broker-Dealer Reports, 76 FR at 37604. 194 See IMS Letter. 195 See 17 CFR 1.10(b)(ii). Rule 1.10 also provides that if the FCM is registered with the Commission as a broker-dealer, the FCM must file the report not later than the time permitted for filing an annual audit report under Rule 17a-5. The Commission is adopting, with modifications, the proposed amendment to paragraph (d)(5) of Rule 17a-5. 196 The modifications add the term “calendar” to make explicit that the time for filing the annual reports is 60 calendar days after the fiscal year end (as opposed to business days). The modifications replace the words “date of the financial statements” with the words “end of the fiscal year of the broker or dealer” to provide consistency in the language of Rule 17a-5. 197 The final rule does not change the time limit for filing the annual reports to 90 days after the end of the fiscal year. The 60-day time frame is a long standing requirement and it provides the Commission and other regulators with relatively current information to, among other things, monitor the financial condition of broker-dealers. Further, broker-dealers may seek an extension of time to file the annual reports from their DEAs. 198 196 See paragraph (d)(5) of Rule 17a-5. 197 Id. See also paragraph (n) of Rule 17a-5. 198 See paragraph (m) of Rule 17a-5. 6. Filing of Annual Reports With SIPC—Paragraph (d)(6) of Rule 17a-5 Prior to today's amendments, paragraph (d)(6) of Rule 17a-5 provided that the “annual audit report” must be filed at the regional office of the Commission for the region in which the broker-dealer has its principal place of business, the Commission's principal office in Washington, DC, and the principal office of the DEA of the broker-dealer. 199 Copies were required to be provided to all self-regulatory organizations (“SROs”) of which the broker-dealer is a member. 199 See 17 CFR 240.17a-5(d)(6). i. The Proposed Amendments The Commission proposed two amendments to this provision. First, the Commission proposed that an SRO that is not a broker-dealer's DEA could by rule waive the requirement that broker-dealers file annual reports with it because many SROs do not believe that it is necessary to receive copies of broker-dealer annual reports if they are not the broker-dealer's DEA. 200 The Commission received no comments on this proposal and is adopting it as proposed. 201 200 See Broker-Dealer Reports, 76 FR at 37592. 201 See paragraph (d)(6) of Rule 17a-5. Second, the Commission proposed amending this provision to require a broker-dealer to file its annual reports with SIPC. 202 SIPC, a nonprofit, nongovernmental membership corporation established by SIPA, is responsible for providing financial protection to customers of failed broker-dealers. SIPA also provided for the establishment of a fund (“SIPC Fund”) to pay for SIPC's operations and activities. SIPC uses the fund to make advances to satisfy customer claims for securities and cash that cannot be readily returned to the customer. SIPA limits the amount of the advance to $500,000 per customer, of which $250,000 can be used to satisfy the cash portion of a customer's claim. The SIPC Fund also covers the administrative expenses of liquidation proceedings for failed broker-dealers when the general estate of the failed firm is insufficient; these include costs incurred by a trustee, trustee's counsel, and other advisors. SIPC finances the SIPC Fund through annual assessments, set by SIPC, on all member firms, plus interest generated from its permitted investments. Generally, all broker-dealers registered with the Commission under section 15(b) of the Exchange Act 203 are required to be members of SIPC. 204 Before today's amendments, broker-dealers were required to file only limited information with SIPC. Specifically: (1) Information elicited on Form SIPC-6, the “General Assessment Payment Form;” (2) information elicited on Form SIPC-7, the “Annual General Assessment Reconciliation;” and (3) for periods in which the SIPC assessment is not a minimum assessment, a comparison by the independent public accountant of the amounts reflected in the annual report the broker-dealer filed with the Commission with amounts reported on Form SIPC-7. 202 See Broker-Dealer Reports, 76 FR at 37592. 203 See 15 U.S.C. 78o(b). 204 See 15 U.S.C. 78ccc(a)(2). However, broker-dealers engaged exclusively in the distribution of mutual fund shares, the sale of variable annuities, the insurance business, the furnishing of investment advice to investment companies or insurance company separate accounts, or whose principal business is conducted outside the U.S. are not required to be members of SIPC. See 15 U.S.C. 78ccc(a)(2)(A)(i)-(iii). The Commission explained in the proposing release that the proposed requirement for broker-dealers to file their annual reports with SIPC could allow SIPC to better monitor industry trends and enhance its knowledge of particular firms. 205 The Commission also explained that the requirement that broker-dealers file copies of their annual reports with SIPC was designed to address cases where the SIPC Fund has been used to pay the administrative expenses of the liquidation of a failed broker-dealer and SIPC sought to recover the money advanced when the estate had insufficient assets. 206 In some of these cases, SIPC has sought to recover money damages from the broker-dealer's auditing firm based on an alleged failure to comply with auditing standards. At least one court, however, has held under New York law that SIPC could not maintain such a claim because it was not a recipient of the annual audit filing and could not have relied on it. 207 205 See Broker-Dealer Reports, 76 FR at 37592. 206 Id. See also SIPC, 2010 Annual Report, at 18, available at http://www.sipc.org/pdf/2010%20Annual%20Report.pdf . 207 See SIPC v. BDO Seidman, LLP, 746 NE.2d 1042 (N.Y. 2001). ii. Comments Received The Commission received seven comments on the proposal that broker-dealers be required to file their annual reports with SIPC. 208 Six commenters generally opposed the requirement. 209 One commenter indicated that it is appropriate for broker-dealers to file their annual reports with SIPC if SIPC uses the reports to reconcile the annual reports with the Form SIPC-7 or otherwise places reliance on them. 210 Three of the commenters stated that the Commission failed to adequately articulate the policy considerations driving the proposed change and also failed to discuss the possible costs of increased litigation risk to accountants. 211 Some of the commenters argued that this change would contradict limitations on SIPC's authority to bring claims against accountants under SIPA and the securities laws imposed by the U.S. Supreme Court. 212 208 See CAQ Letter; Deloitte Letter; E&Y Letter; Grant Thornton Letter; KPMG Letter; McGladrey Letter; PWC Letter . 209 See CAQ Letter; Deloitte Letter; E&Y Letter; Grant Thornton Letter; KPMG Letter; PWC Letter . 210 See McGladrey Letter. Form SIPC-7 is discussed in more detail below in section II.C.4. of this release. 211 See CAQ Letter; Deloitte Letter; KPMG Letter . 212 See CAQ Letter; Deloitte Letter; E&Y Letter; KPMG Letter; PWC Letter . After the proposal, a task force established by SIPC to undertake a comprehensive review of SIPA and SIPC's operations and policies and to propose reforms to modernize SIPA and SIPC recommended to the SIPC Board that SIPC members be required to file audit reports with SIPC concurrently with their filing with the SEC, a position consistent with the proposal. In a report presented to the SIPC Board of Directors in February 2012, 213 the task force stated that including SIPC as a designated recipient of the audit report “would further the goal of investor protection by providing another layer of review of the report by an organization directly affected by its contents.” 214 In addition, the task force stated that “including SIPC as a recipient would help to address the persistent concern that any signs of `financial weakness, as by non-compliance with net capital requirements or otherwise, [be] watched very carefully and followed up' in order to augment the financial responsibility requirements SIPA was intended to enhance, and to provide greater investor protection.” 215 213 See Report and Recommendations of the SIPC Modernization Task Force (Feb. 2012), available at http://www.sipc.org/pdf/Final%Report%202012.pdf . The Task Force was comprised of volunteers, and included investor advocates, regulatory specialists, and academic experts, including the trustee for the liquidation of Lehman Brothers Inc. and MF Global Inc. 214 See Report and Recommendations of the SIPC Modernization Task Force, at 19. 215 Id. (quoting the SEC, Study of Unsafe and Unsound Practices of Broker-Dealers, H.R. Doc. No. 92-231, at 152 (1971)). iii. The Final Rule The Commission is adopting the amendment requiring broker-dealers to file their annual reports with SIPC substantially as proposed. 216 SIPC plays an important role in the securities markets and the SIPC Fund can help reduce losses to investors from the failure of their broker-dealer. SIPC has a legitimate interest in receiving the annual reports of its broker-dealer members to assist it with its maintenance of the SIPC Fund and to monitor trends in the broker-dealer industry. SIPC presently obtains revenue information from broker-dealers, through Form SIPC-7, to determine how best to structure broker-dealer assessments to maintain the SIPC Fund at an appropriate level. However, the information collected in the form is limited and may not assist SIPC in assessing whether the SIPC Fund is appropriately sized to the risks of a large broker-dealer failure. The annual audited reports contain much more detailed information about the assets, liabilities, income, net capital, and Rule 15c3-3 customer reserve requirements of broker-dealers, and also include, for carrying broker-dealers, a compliance report containing information about the broker-dealer's compliance with, and controls over compliance with, the broker-dealer financial responsibility rules. The annual reports also generally include the independent public accountant's reports covering the financ [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2013-18738. Public record. Not legal advice.