Proposed Rule Would Increase SEC Oversight of Broker-Dealer Custody Practices

Rule 17a-5 under the Exchange Act requires broker-dealers to undergo an annual audit conducted by an independent public accountant and to file an annual report containing audited financial statements and certain supporting schedules with the SEC and the broker-dealer’s designated examining authority (i.e. FINRA). On June 15, 2011, the SEC proposed amendments to financial reporting rule, which would require the annual audits to focus on the custody activities of broker-dealers, and provide the SEC and FINRA with additional information about the custody practices of broker-dealers in order enhance their regulatory examinations.

Under the proposed amendments, broker-dealers that maintain custody of customer securities and cash would be required to undergo an audit by a PCAOB-registered accounting firm that examines: (i) whether the broker-dealer is in compliance with certain rules designed to protect and account for these assets; and (ii) the broker-dealer’s internal controls for complying with these rules. Broker-dealers that do not maintain custody of customer assets would be required to undergo a review by an independent public accountant of its assertion that it is not subject to segregation requirements because it does not maintain custody. The proposed amendments are also designed to enhance regulatory examinations by requiring broker-dealers with custody to allow regulators to review the work papers of, and discuss findings with, the accounting firm that performed the audit. Additionally, the proposal would require broker-dealers to file, on a quarterly basis, a new “Form Custody” report containing information about the broker-dealer’s custody practices, the contents of which would be used by regulators for examinations.

The proposal builds upon the amendments to the investment adviser custody rule adopted in 2009 and is the latest indication of the SEC’s continued focus on the adequacy of firms’ procedures for safeguarding and protecting customer and client assets from misappropriation. For additional information on the proposed amendments to Rule 17a-5, please contact Zac Rosenberg, Compliance Consultant by email at zachary.rosenberg@corecls.com or by phone at (619) 278-0020.