The Securities and Exchange Commission has approved the creation of an interim inspection program related to audits of brokers and dealers.

The program was proposed by the Public Company Accounting Oversight Board, as a result of the Dodd-Frank Wall Street Reform Act and will be carried out by the board.

The proposal is designed strengthen oversight of how broker dealers handle trillions of dollars in client assets. But it could end up costing brokers an arm and a leg without helping investors, say compliance and operations experts.

The SEC wants brokers dealers to tell the regulator on a quarterly basis whether they have access to client funds and how that access is controlled.

While current rules do require broker-dealers to protect customer assets, the new rule would also allow internal audits to be checked by a registered public accounting firm.

The SEC could review the work papers of the public accounting firm that audits the broker-dealer and discuss its findings with the accounting firm. The examiners could then use the information gathered to better focus their exams.

What if a firm doesn’t safekeep any client assets? It still has to prove that through an audit. The SEC estimates that of the 5,000 brokerages registered with the agency about 300 have custody of their customers’ assets.

The SEC said it had received one comment.

The SEC’s proposal complements regulations adopted in late 2009 that tightened custody rules for investment advisers and subjected them to surprise audits. SEC Commissioner Louis Aguilar said the proposal would make “long overdue improvements.” The regulator failed to catch Bernard Madoff’s Ponzi scheme despite numerous tips and examinations. Madoff’s investment advisory business and broker-dealer businesses were registered.

“We don’t know whether custody exams would protect customers any more than current rules in place that govern broker-dealer financial operations,” says Todd Cipperman, principal of Cipperman & Co, a Wayne, Penn law firm.

Francois Cooke, managing director in the Boca Raton, Fla. office of ACA Compliance, a compliance firm specializing in broker-dealers agrees. "There may be an additional level of granularity required but it is unclear whether there will be a significant difference between the current practice of financial audits and the new requirements," he said. "For smaller brokerages grapplilng with declining margins it [the SEC's proposals] could prove costly."

The preliminary industry consensus: Audit expenses will go up. “We anticipate spending at least $50,000 more in annual audit fees,” said one operations executive at a New York brokerage firm.

Yet another operations executive at a New York brokerage firm said the additional audit costs could come to as much as $100,000 annually.”It’s all about preventing another Madoff scenario where the SEC dropped the ball but I don’t envision it improving compliance,” he said, also declining to be identified.

The SEC says that its goal is to verify whether the broker-dealer has sufficient controls in place to meet its net capital rule; the customer protection rule; the quarterly security count rule; and the account statement rule

Under the net capital rule – Rule 15c3-1—broker-dealers must maintain more than a dollar of highly liquid assets for each dollar of liabilities. The customer protection rule – Rule 15c3-3 -- requires broker dealers to segregate customer securities and cash from its proprietary business activities.


Register or login for access to this item and much more

All On Wall Street content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access