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 financial report and compliance
report or exemption report, as applicable, prepared by the broker-
dealer. This information will assist SIPC in monitoring the financial
strength of broker-dealers and, therefore, in assessing the adequacy of
the SIPC Fund.\217\
---------------------------------------------------------------------------

    \216\ See paragraph (d)(6) of Rule 17a-5. The Commission
clarified that the broker-dealer must file the annual reports with
SIPC only ``if the broker or dealer is a member of SIPC.'' The
Commission believes that SIPC has an interest in receiving annual
reports only from broker-dealers that are SIPC members, because only
these broker-dealers may pose a risk to the SIPC Fund.
    \217\ See McGladrey Letter.
---------------------------------------------------------------------------

    In addition, by receiving the annual reports, SIPC may be able to
overcome a legal hurdle to pursuing claims against a broker-dealer's
accountant where the accountant's failure to adhere to professional
standards in auditing a broker-dealer caused a loss to the SIPC Fund.
Although this amendment is intended to remove one potential legal
hurdle to SIPC actions against accountants, the other elements of any
relevant cause of action would be unaffected. The Commission does not
intend by this amendment to take a position on the circumstances under
which SIPC may have a viable cause of action against an independent
public accountant.\218\
---------------------------------------------------------------------------

    \218\ Several commenters argue that requiring the annual report
to be filed with SIPC would contradict limitations the Supreme Court
has imposed on SIPC's authority to bring claims against accountants.
The decisions cited by these commenters, however, do not speak to
the precise issue the amended rule is intended, among other things,
to address--the New York Court of Appeals' decision held that SIPC
could not state a cause of action for either fraudulent or negligent
misrepresentation against an auditing firm because it was not a
recipient of the annual audit report. See SIPC v. BDO Seidman, LLP,
746 NE.2d 1042 (N.Y. 2001); aff'd, 245 F.3d 174 (2d Cir. 2001).
Rather, in Holmes v. Securities Investor Protection Corporation, the
Supreme Court found that the statutory provision relied on by SIPC,
15 U.S.C. 78eee(d), did not, either alone or with the Racketeer
Influenced and Corrupt Organizations Act, confer standing. 503 U.S.
258, 275 (1992). And, in Touche Ross & Co. v. Redington, the Supreme
Court determined that customers of securities brokerage firms do not
have an implied cause of action for damages under section 17(a) of
the Exchange Act against accountants who audit the financial reports
filed by such firms; thus, SIPC could not assert this implied cause
of action on behalf of these customers. 442 U.S. 560, 567 (1979). As
already noted, the Commission does not intend by this amendment to
take a position on the circumstances under which SIPC may have a
viable cause of action against an independent public accountant.
---------------------------------------------------------------------------

    Several commenters stated that the Commission did not address the
potential costs and benefits of requiring broker-dealers to file copies
of their annual reports with SIPC, including potential accounting
litigation costs.\219\ As discussed below in section VII. of this
release, the Commission recognizes that there may be increased
litigation costs (or reserves for potential litigation costs) as a
result of the amendment and that to the extent that there are such
costs, some of them may be passed on to broker-dealers in the form of
increased audit fees. But, while this amendment may facilitate the
ability of SIPC to bring actions against accountants for malpractice or
material misrepresentation under state law by removing one potential
legal hurdle to such actions, it will not necessarily result in a
significant increase in such actions. Generally, SIPC initiates a small
number of proceedings each year, and most of these proceedings have not
involved a claim against a broker-dealer's accountant. Specifically,
SIPC was established in 1971. In the period from 1971-2011, SIPC
initiated 324 proceedings under SIPA to liquidate a failed broker-
dealer.\220\ This results in an average of approximately 8 SIPA
proceedings per year, though 109 of the 324 proceedings were initiated
in the period from 1971-1974, which was the immediate aftermath of the
financial crisis of 1968-1970.\221\ According to SIPC staff, SIPC has
brought 9 lawsuits against accountants since 1971, which is one lawsuit
for every 36 SIPA proceedings.\222\ Accordingly, the likelihood of a
lawsuit against an accountant is small and the Commission anticipates
that the overall costs related to litigation as a result of the filing
requirement should not be significant. The Commission believes that any
such costs are justified by the benefits of enhanced customer
protection and the associated ability of SIPC to better assess the
financial condition of broker-dealers and the adequacy of the SIPC
Fund.
---------------------------------------------------------------------------

    \219\ See, e.g., CAQ Letter; Deloitte Letter; KPMG Letter.
    \220\ See SIPC, Annual Report 2011, at 6.
    \221\ Id. See also Commission, Study of Unsafe and Unsound
Practices of Brokers and Dealers: Report and Recommendations of the
Securities and Exchange Commission (December 1971) (discussing the
financial crisis of 1968-1970). Since its inception through 2001,
SIPC initiated 299 proceedings under SIPA.
    \222\ See Redington v. Touche Ross & Co., 592 F.2d 617 (2d Cir.
1978); In re Bell & Beckwith, 77 B.R. 606 (Bkrtcy. N.D. Ohio, 1987);
Mishkin v. Peat, Marwick, Mitchell & Co., 658 F.Supp. 271 (S.D.N.Y.
1987); SIPC v. BDO Seidman, LLP, 49 F.Supp.2d 644 (S.D.N.Y. 1999);
In re Donahue Securities Inc., 2004 WL 3152763 (Bkrtcy S.D. Ohio,
2004); In re SIPC v. R.D. Kushnir & Co, 274 B.R. 768 (Bkrtcy. N.D.
Ill., 2002); In re Sunpoint Securities, Inc., 377 B.R. 513 (Bkrtcy.
E.D. Tex., 2007); Compliant at 5-6, Gilbert v. Ohab, Bkrtcy. M.D.
Fl. (May 2010) (No. 6:08-ap-00145-KSJ); Complaint at 2, Shively v.
Mortland, Bkrtcy. D. Co. (Feb. 2004) (No. 03-BK-1102-HRT).
---------------------------------------------------------------------------

C. The Nature and Form of the Annual Reports

1. Exemptions From Audit Requirement--Paragraph (e)(1) of Rule 17a-5
    Prior to today's amendments, paragraph (e)(1)(i) of Rule 17a-5
provided, among other things, that the audit of the broker-dealer's
financial statements needed to be performed by an accountant that is
independent as defined in paragraph (f) of Rule 17a-5.\223\ Paragraph
(e)(1)(i) also contained provisions under which certain broker-dealers
were not required to engage an accountant to audit their financial
statements.\224\
---------------------------------------------------------------------------

    \223\ See 17 CFR 240.17a-5(e)(1)(i).
    \224\ Id.
---------------------------------------------------------------------------

    The Commission proposed amending paragraph (e)(1)(i) of Rule 17a-5
to remove the words ``An audit shall be conducted by a public
accountant who shall be in fact independent as defined in paragraph
(f)(3) of this section herein, and he shall give an opinion covering
the statements filed pursuant to paragraph (d).'' This amendment would
consolidate the requirements with respect to the qualifications of the
accountant in paragraph (f) of Rule 17a-5, and paragraph (e)(1)(i) of
Rule 17a-5 would address only exemptions from the requirement to engage
an independent public accountant to audit the annual reports prepared
by the broker-dealer.\225\ The Commission received no comments on this
proposal, and is adopting it with modifications.\226\ The
modifications: (1) Modernize certain terms in the rule in a manner
consistent with the Commission's ``plain English'' initiative; and (2)
cite to the reports required under ``Rule 17a-5(d)(1)(i)(C)'' to
provide a more precise cross reference than the former citation to
reports required under ``Rule 17a-5(d).'' \227\
---------------------------------------------------------------------------

    \225\ See Broker-Dealer Reports, 76 FR at 37593-37594. The
proposed and final amendments to paragraph (f) of Rule 17a-5 are
discussed below in section II.E. of this release.
    \226\ See paragraph (e)(1)(i) of Rule 17a-5.
    \227\ Id. Prior to today's amendments, paragraph (e)(1)(ii) of
Rule 17a-5 provided that ``[a] broker or dealer who files a report
which is not covered by an accountant's opinion shall include in the
oath or affirmation required by paragraph (e)(2) of this section a
statement of the facts and circumstances relied upon as a basis for
exemption from the requirement that financial statements and
schedules filed pursuant to paragraph (d) of this section be covered
by the opinion of an accountant.'' See 17 CFR 240.17a-5(e)(1)(ii).
The Commission did not propose amendments to this subparagraph.
However, to be consistent with today's amendments, the Commission is
making technical amendments to paragraph (e)(1)(ii) of Rule 17a-5 so
that it now provides that ``[a] broker or dealer that files annual
reports under paragraph (d) of this section that are not covered by
reports prepared by an independent public accountant must include in
the oath or affirmation required by paragraph (e)(2) of this section
a statement of the facts and circumstances relied upon as a basis
for exemption from the requirement that the annual reports filed
under paragraph (d) of this section be covered by reports prepared
by an independent public accountant.'' See paragraph (e)(1)(ii) of
Rule 17a-5.

---------------------------------------------------------------------------

2. Affirmation--Paragraph (e)(2) of Rule 17a-5
    Prior to today's amendments, paragraph (e)(2) of Rule 17a-5
provided that an oath or affirmation must be attached to the annual
audit report that, to the best knowledge and belief of the person
making the oath or affirmation, the financial statements and schedules
are true and correct and, among other things, that the oath or
affirmation must be made by the proprietor if a sole proprietorship, by
a general partner, if a partnership, or by a duly authorized officer,
if a corporation.\228\ The Commission proposed amending the first
sentence of paragraph (e)(2) of Rule 17a-5 by adding the word
``financial'' before the word ``report.''\229\ The Commission is
adopting this amendment as proposed.
---------------------------------------------------------------------------

    \228\ See 17 CFR 240.17a-5(e)(2).
    \229\ See Broker-Dealer Reports, 76 FR at 37603.
---------------------------------------------------------------------------

    One commenter stated that currently paragraph (e)(2) of Rule 17a-5
does not specifically cover limited liability companies, and its
reference to partnerships assumes that a general partner is a natural
person.\230\ The commenter argued that it should be updated to conform
to generally accepted business laws.
---------------------------------------------------------------------------

    \230\ See IMS Letter.
---------------------------------------------------------------------------

    In response to this comment, the Commission is adopting amendments
to paragraph (e)(2) of Rule 17a-5 that modify the proposed
amendments.\231\ In particular, the Commission is adding that if the
broker-dealer is a limited liability company or limited liability
partnership, the oath or affirmation must be made by the chief
executive officer, chief financial officer, manager, managing member,
or any of those members vested with management authority for the
limited liability company or limited liability partnership.\232\
---------------------------------------------------------------------------

    \231\ See paragraph (e)(2) of Rule 17a-5.
    \232\ See IMS Letter.
---------------------------------------------------------------------------

3. Confidentiality of Annual Reports--Paragraph (e)(3) of Rule 17a-5
    Prior to today's amendments, paragraph (e)(3) of Rule 17a-5
provided that the financial statements filed under paragraph (d) are
public, except that if the Statement of Financial Condition is bound
separately from the balance of the annual audited financial statements
filed under paragraph (d)(1), the balance of the annual audited
financial statements will be deemed confidential.\233\ As noted in the
proposing release, the wording of this provision has led to
confusion.\234\ In particular, Commission staff has received inquiries
on how broker-dealers can indicate that they are requesting
confidential treatment for the portion of the financial statements
intended to be kept confidential to the extent permitted by law and, on
occasion, financial statements broker-dealers intended to be
confidential are inadvertently made public.\235\ This could happen, for
example, if a broker-dealer fails to bind the balance sheet separately
from the other portion of the financial statements when it files the
financial statements with the Commission.\236\
---------------------------------------------------------------------------

    \233\ See 17 CFR 240.17a-5(e)(3).
    \234\ See Broker-Dealer Reports, 76 FR at 37592-37593.
    \235\ The public portions of broker-dealer annual audited
reports are available on the Commission's Web site. These reports
may be accessed via the Search for Company Filings link under
Filings & Forms on the Commission's home page.
    \236\ The Commission staff has previously posted guidance on the
Commission Web site on how to request confidential treatment for the
financial statements other than the statement of financial
condition. See http://www.sec.gov/divisions/marketreg/bdnotices.htm.
---------------------------------------------------------------------------

    Consequently, the Commission proposed amending paragraph (e)(3) of
Rule 17a-5 to provide that the annual reports filed pursuant to
paragraph (d) are public, except that if the Statement of Financial
Condition is bound separately from the annual report filed pursuant to
``paragraph (d)(2) of Rule 17a-5,'' and each page of the balance of the
annual report is stamped ``confidential,'' the balance of the annual
report shall be deemed confidential.\237\ The proposed rule text
inadvertently referenced only the financial report. It was intended
that the financial report, compliance report, exemption report, and
related accountant reports would be treated the same under paragraph
(e)(3) of Rule 17a-5. Consequently, the Commission is modifying the
proposed amendment. Specifically, paragraph (e)(3) of Rule 17a-5, as
adopted, provides that if the Statement of Financial Condition is bound
separately from the balance of the ``annual reports filed under
paragraph (d) of this section,'' and each page of the balance of the
annual reports is stamped ``confidential,'' then the balance of the
annual reports will be deemed confidential to the extent permitted by
law.\238\ Consequently, if the compliance reports and exemption reports
and the related reports of the independent public accountant are
submitted in accordance with the procedures specified in paragraph
(e)(3) of Rule 17a-5, these reports will be deemed confidential to the
extent permitted by law.\239\
---------------------------------------------------------------------------

    \237\ See Broker-Dealer Reports, 76 FR at 37592-37593.
    \238\ See paragraph (e)(3) of Rule 17a-5.
    \239\ See 5 U.S.C. 552 et seq. (Freedom of Information Act--
``FOIA''). FOIA provides at least two potentially pertinent
exemptions under which the Commission has authority to withhold
certain information. FOIA Exemption 4 provides an exemption for
``trade secrets and commercial or financial information obtained
from a person and privileged or confidential.'' 5 U.S.C. 552(b)(4).
FOIA Exemption 8 provides an exemption for matters that are
``contained in or related to examination, operating, or condition
reports prepared by, on behalf of, or for the use of an agency
responsible for the regulation or supervision of financial
institutions.'' 5 U.S.C. 552(b)(8). However, as discussed below,
under paragraph (c)(2)(iv) of Rule 17a-5, if there are material
weaknesses, the accountant's report on the compliance report must be
made available for customers' inspection and, consequently, it would
not be deemed confidential. In addition, paragraph (c)(2)(i) of Rule
17a-5 (which is not being amended today) requires a broker-dealer to
furnish to its customers annually a balance sheet with appropriate
notes prepared in accordance with GAAP and which must be audited if
the broker-dealer is required to file audited financial statements
with the Commission. See 17 CFR 240.17a-5(c)(2)(i).
---------------------------------------------------------------------------

    Prior to today's amendments, paragraph (e)(3) of Rule 17a-5 also
provided that the broker-dealer's reports, including the confidential
portions, will be available, for example, for official use by any
official or employee of the U.S. and an official or employee of any
national securities exchange and registered national securities
association of which the broker-dealer is a member and ``by any other
person to whom the Commission authorizes disclosure of such information
as being in the public interest.'' \240\ The Commission proposed
amending this list of permitted recipients to include the PCAOB.\241\
The Commission did not receive comments on this proposal and is
adopting it essentially as proposed with a minor wording edit for
clarity.\242\
---------------------------------------------------------------------------

    \240\ See 17 CFR 240.17a-5(e)(3).
    \241\ See Broker-Dealer Reports, 76 FR at 37592-37593.
    \242\ See paragraph (e)(3) of Rule 17a-5.
---------------------------------------------------------------------------

4. Supplemental Report on SIPC Membership--Paragraph (e)(4) of Rule
17a-5
    As discussed above in section II.B.6. of this release, SIPC
maintains the SIPC Fund to be used in liquidations of broker-dealers
under SIPA. The SIPC Fund is established and maintained through
assessments on broker-dealers that are required to be members of

SIPC.\243\ In order to assist in the collection of assessments from
member broker-dealers, SIPC has promulgated two forms that broker-
dealers must file with SIPC, as applicable: Form SIPC-3 and Form SIPC-
7. Form SIPC-3 is required when a broker-dealer is claiming an
exemption from SIPC membership (i.e., when the broker-dealer does not
have to pay an assessment). In this case, the broker-dealer must file
Form SIPC-3 each year certifying that the broker-dealer remained
qualified for the exemption during the prior year. Form SIPC-7 elicits
information from a broker-dealer that is a SIPC member about the
broker-dealer's sources of revenue attributable to its securities
business. Every broker-dealer that is a member of SIPC must file this
form annually.
---------------------------------------------------------------------------

    \243\ 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).
---------------------------------------------------------------------------

    Prior to today's amendments, paragraph (e)(4) of Rule 17a-5
provided that a broker-dealer must file with its annual report a
supplemental report on the status of the membership of the broker-
dealer in SIPC, which was required to be ``covered by an opinion of the
independent public accountant'' if the annual report of the broker-
dealer was required to be audited.\244\ Among other things, the
supplemental report needed to cover the SIPC annual general assessment
reconciliation or exclusion from membership forms (i.e., Form SIPC-7 or
Form SIPC-3).\245\ Paragraph (e)(4)(iii) of Rule 17a-5 used the terms
``review'' and ``opinion'' in describing the accountant's report that
must cover the supplement report.\246\ In addition, it required that
the review by the accountant include certain minimum procedures.\247\
---------------------------------------------------------------------------

    \244\ See 17 CFR 240.17a-5(e)(4).
    \245\ Id.
    \246\ See 17 CFR 240.17a-5(e)(4)(iii).
    \247\ See 17 CFR 240.17a-5(e)(4)(iii)(A)-(F).
---------------------------------------------------------------------------

    Under this provision, the supplemental report did not need to be
filed if the SIPC Fund assessments were the minimum assessment provided
for under SIPA.\248\ Between 1996 and 2009, the annual assessment for
SIPC members remained at the $150 minimum assessment level provided for
under SIPA.\249\ In 2009, SIPC raised the assessment above the minimum,
which triggered the requirement in paragraph (e)(4) of Rule 17a-5 to
file a supplemental report with the Commission, the broker-dealer's
DEA, and SIPC.\250\
---------------------------------------------------------------------------

    \248\ See 17 CFR 240.17a-5(e)(4); 15 U.S.C. 78ddd(d)(1)(c).
    \249\ See SIPC, SIPC to Reinstitute Assessments of Member Firms'
Operating Revenues (Mar. 2, 2009) (news release).
    \250\ Id.
---------------------------------------------------------------------------

    The Commission stated in the proposing release that, because Forms
SIPC-3 and SIPC-7 are used solely by SIPC for purposes of levying its
assessments, the supplemental report required pursuant to paragraph
(e)(4) of Rule 17a-5 relating to these forms would be more
appropriately filed exclusively with SIPC and that SIPC (rather than
the Commission) should prescribe by rule the form of the supplemental
report.\251\ The Commission stated that it would continue to have a
role in establishing the requirements for a supplemental report because
the Commission must approve SIPC rules.\252\
---------------------------------------------------------------------------

    \251\ See Broker-Dealer Reports, 76 FR at 37582.
    \252\ Id.
---------------------------------------------------------------------------

    For these reasons, the Commission proposed to amend paragraph
(e)(4) of Rule 17a-5 to require that broker-dealers file with SIPC a
report on the SIPC annual general assessment reconciliation or
exclusion from membership forms that contains such information and is
in such format as determined by SIPC by rule and approved by the
Commission.\253\ However, because there would be an interim period
before a rule determined by SIPC became effective, the Commission
proposed amendments to paragraph (e)(4) under which broker-dealers
would continue to file a supplemental report with the Commission, the
broker-dealer's DEA, and SIPC until SIPC adopts a rule pursuant to
paragraph (e)(4)(i) of Rule 17a-5 and the rule is approved by the
Commission.\254\ Consequently, a broker-dealer would be required to
file the SIPC supplemental reports with SIPC using the existing formats
for the reports until the earlier of the Commission approving a rule
adopted by SIPC or two years. If after two years, a rule promulgated by
SIPC has not been approved by the Commission, broker-dealers would no
longer be required to file these reports.
---------------------------------------------------------------------------

    \253\ Id.
    \254\ Id.
---------------------------------------------------------------------------

    Further, to facilitate this change, the Commission proposed to
update the rule text to conform it to existing professional standards
and industry practices.\255\ Specifically, the Commission proposed
amending paragraph (e)(4) of Rule 17a-5 to eliminate the ambiguity that
stems from the differing auditing terms used in that rule by removing
all references to ``review'' and ``opinion.'' \256\ In their place, the
Commission proposed that the supplemental report include an independent
public accountant's report based on the performance of the procedures
listed in paragraph (e)(4)(iii) of Rule 17a-5, which the Commission did
not propose to change.\257\
---------------------------------------------------------------------------

    \255\ Id.
    \256\ Id.
    \257\ See Broker-Dealer Reports, 76 FR at 37582. The Commission
proposed one modification to the procedures listed in former
paragraph (e)(4)(iii); namely, amending the procedure described in
paragraph (e)(4)(iii)(F), which is now renumbered (e)(4)(ii)(6), to
change the reference from ``Form SIPC-7'' to ``Form SIPC-3'' because
the reference to Form SIPC-7 is inaccurate. Id.
---------------------------------------------------------------------------

    The Commission received two comments relating to the proposed
amendments to paragraph (e)(4) of Rule 17a-5, both of which supported
the proposed change.\258\ One commenter indicated that the proposed
amendment would decrease the burden on broker-dealers associated with
filing the supplemental report with the Commission and the broker-
dealer's DEA.\259\ In addition, the other commenter indicated that
until the supplemental reports are filed exclusively with SIPC, they
should be subject to confidential treatment.\260\
---------------------------------------------------------------------------

    \258\ See CAI Letter; McGladrey Letter.
    \259\ See CAI Letter.
    \260\ See McGladrey Letter.
---------------------------------------------------------------------------

    The Commission is adopting the amendments to paragraph (e)(4) of
Rule 17a-5 as proposed.\261\ With respect to the comment about the
Commission keeping the supplemental report confidential, a broker-
dealer can request confidential treatment for the report.\262\ If such
a request is made, the Commission anticipates that it will accord the
supplemental report confidential treatment to the extent permitted by
law.\263\
---------------------------------------------------------------------------

    \261\ See paragraph (e)(4) of Rule 17a-5.
    \262\ See 17 CFR 200.83. Information about how to request
confidential treatment of information submitted to the Commission is
available at http://www.sec.gov/foia/howfo2.htm#privacy.
    \263\ See, e.g., Exchange Act section 24, 15 U.S.C. 78x
(governing the public availability of information obtained by the
Commission) and 5 U.S.C. 552 et seq. (Freedom of Information Act--
``FOIA''). FOIA provides at least two pertinent exemptions under
which the Commission has authority to withhold certain information.
FOIA Exemption 4 provides an exemption for ``trade secrets and
commercial or financial information obtained from a person and
privileged or confidential.'' 5 U.S.C. 552(b)(4). FOIA Exemption 8
provides an exemption for matters that are ``contained in or related
to examination, operating, or condition reports prepared by, on
behalf of, or for the use of an agency responsible for the
regulation or supervision of financial institutions.'' 5 U.S.C.
552(b)(8).

---------------------------------------------------------------------------

D. Engagement of the Accountant

    As part of today's amendments to the broker-dealer annual reporting
requirements in Rule 17a-5, the Commission is amending certain
requirements relating to a broker-dealer's engagement of an independent
public accountant. Specifically, the Commission is requiring that a
broker-dealer engage an independent public accountant to prepare
reports based on an examination of the broker-dealer's financial report
and either an examination of certain statements in the broker-dealer's
compliance report or a review of certain statements in the broker-
dealer's exemption report. The examinations and reviews must be made in
accordance with the standards of the PCAOB, consistent with the
explicit authority granted to the PCAOB by the Dodd-Frank Act to
establish (subject to Commission approval) auditing and attestation
standards with respect to broker-dealer audits.\264\ Among other
things, the amendments replace provisions that required the filing of a
``material inadequacy'' report and are intended to update terminology
in the rule to make the rule's requirements clear and to provide for a
more consistent approach to engaging broker-dealer independent public
accountants.
---------------------------------------------------------------------------

    \264\ See Public Law 111-203 Sec.  982.
---------------------------------------------------------------------------

    This section addresses statutory requirements for broker-dealer
annual reports and the Commission's authority with regard to these
reports, describes the engagement of accountant requirements in Rule
17a-5 prior to today's amendments, summarizes the Commission's proposed
amendments and comments received, and discusses the final rule
amendments.
1. Statutory Requirements and Commission Authority
    Section 17(e)(1)(A) of the Exchange Act requires a broker-dealer to
file annually with the Commission a ``certified'' balance sheet and
income statement as well as ``such other financial statements (which
shall, as the Commission specifies, be certified) and information
concerning its financial condition as the Commission, by rule, may
prescribe as necessary or appropriate in the public interest or for the
protection of investors.'' \265\ Section 17(e)(2) of the Exchange Act
provides the Commission with authority, by rule, to prescribe the form
and content of the financial statements and the accounting principles
and standards used in their preparation as it deems necessary or
appropriate in the public interest or for the protection of
investors.\266\ In addition, section 17(a) of the Exchange Act more
generally requires registered broker-dealers to make and disseminate
such reports as the Commission, by rule, may prescribe as necessary or
appropriate in the public interest, for the protection of
investors.\267\ The Commission adopted Rule 17a-5, in part, under these
provisions.\268\
---------------------------------------------------------------------------

    \265\ See 15 U.S.C. 78q(e)(1)(A).
    \266\ See 15 U.S.C. 78q(e)(2).
    \267\ See 15 U.S.C. 78q(a).
    \268\ See Broker-Dealer Reports, Exchange Act Release No. 11935
(Dec. 17, 1975), 40 FR 59706 (Dec. 30, 1975).
---------------------------------------------------------------------------

    Prior to the enactment of the Sarbanes-Oxley Act of 2002
(``Sarbanes-Oxley Act''),\269\ section 17(e)(1)(A) required that the
annual financial statements a broker-dealer must file with the
Commission be certified by ``an independent public accountant.'' The
Sarbanes-Oxley Act established the PCAOB \270\ and amended section
17(e)(1)(A) by replacing the words ``certified by an independent public
accountant'' with the words ``certified by a registered public
accounting firm.'' \271\ Title I of the Sarbanes-Oxley Act prescribed
specific PCAOB registration, standards-setting, inspection,
investigation, disciplinary, foreign application, oversight, and
funding programs in connection with audits of issuers.\272\ However, as
originally enacted, the Sarbanes-Oxley Act did not expressly prescribe
similar programs in connection with audits of broker-dealers that are
not issuers.
---------------------------------------------------------------------------

    \269\ Public Law 107-204, 116 Stat. 745 (2002).
    \270\ Public Law 107-204 Sec.  101.
    \271\ See Public Law 107-204 Sec.  205(c)(2). The term
Registered Public Accounting Firm is defined in section 2(a)(12) as
``a public accounting firm registered with the [PCAOB] in accordance
with this Act.'' See Public Law 107-204 Sec.  2(a)(12).
    \272\ Section 2(a)(7) of the Sarbanes-Oxley Act defines the term
issuer as ``an issuer as defined in section 3 of the [Exchange Act],
the securities of which are registered under section 12 of [the
Exchange Act], or that files or has filed a registration statement
that has not yet become effective under the Securities Act of
1933[hellip], and that it has not withdrawn'' (U.S.C. citations
omitted). See Public Law 107-204 Sec.  2(a)(7).
---------------------------------------------------------------------------

    The Dodd-Frank Act, enacted in July 2010, amended the Sarbanes-
Oxley Act to provide the PCAOB with explicit authority to, among other
things, establish (subject to Commission approval) auditing and related
attestation, quality control, ethics, and independence standards for
registered public accounting firms with respect to their preparation of
audit reports to be included in broker-dealer filings with the
Commission, and the authority to conduct and require an inspection
program of registered public accounting firms that audit broker-
dealers.\273\ The Dodd-Frank Act addressed inspection authority by
adding section 104(a)(2)(A) to the Sarbanes-Oxley Act, which provides
that the PCAOB ``may, by rule, conduct and require a program of
inspection* * *of registered public accounting firms that provide one
or more audit reports for a broker or dealer'' and that the PCAOB, in
establishing a program for inspection, ``may allow for differentiation
among classes of brokers or dealers, as appropriate.'' \274\
---------------------------------------------------------------------------

    \273\ See Public Law 111-203 Sec.  982.
    \274\ See Public Law 111-203 Sec.  982(e)(1).
---------------------------------------------------------------------------

    The Dodd-Frank Act also added section 104(a)(2)(D) to the Sarbanes-
Oxley Act, which provides that a public accounting firm is not required
to register with the PCAOB if the public accounting firm is exempt from
an inspection program established by the PCAOB.\275\ The Dodd-Frank Act
made a conforming amendment to section 17(e)(1)(A) of the Exchange Act
to replace the words ``certified by a registered public accounting
firm'' with the words ``certified by an independent public accounting
firm, or by a registered public accounting firm if the firm is required
to be registered under the Sarbanes-Oxley Act of 2002.'' \276\
---------------------------------------------------------------------------

    \275\ Id.
    \276\ See Public Law 111-203 Sec.  982(e)(2). As discussed
below, today's amendments to the qualifications of the independent
public accountant provisions require, consistent with amended
section 17(e)(1)(A), that the accountant be qualified, independent,
and registered with the PCAOB ``if required by the Sarbanes-Oxley
Act of 2002.'' See paragraph (f)(1) of Rule 17a-5.
---------------------------------------------------------------------------

    Before today's amendments, paragraph (g)(1) of Rule 17a-5 required
that audits of broker-dealer reports filed with the Commission under
Rule 17a-5 be made in accordance with generally accepted auditing
standards (``GAAS''), which are established by the Auditing Standards
Board of the American Institute of Certified Public Accountants
(``AICPA''). In light of the authority granted to the PCAOB by the
Dodd-Frank Act to establish standards governing audit reports to be
included in broker-dealer filings with the Commission, the Commission
issued transitional interpretive guidance to clarify that references in
Commission rules, staff guidance, and in the federal securities laws to
GAAS or to specific standards under GAAS, as they relate to non-issuer
brokers or dealers, should continue to be understood to mean auditing
standards generally accepted in the U.S., in addition to any applicable
rules of the Commission.\277\ The

guidance also stated that the Commission intended to revisit the
interpretation in connection with a rulemaking project to update the
audit and related attestation requirements under the federal securities
laws for broker-dealers.\278\ As discussed below, the Commission is now
adopting amendments to Rule 17a-5 to require that audits and
attestations of broker-dealer reports filed under Rule 17a-5 be made in
accordance with standards of the PCAOB--the rule as amended does not
contain references to GAAS.
---------------------------------------------------------------------------

    \277\ See Commission Guidance Regarding Auditing, Attestation,
and Related Professional Practice Standards Related to Brokers and
Dealers, Exchange Act Release No. 62991 (Sept. 24, 2010), 75 FR
60616, 60617 (Oct. 1, 2010).
    \278\ Id.
---------------------------------------------------------------------------

    Since the Commission proposed these amendments, the PCAOB has taken
a number of actions to implement the explicit authority over broker-
dealer audits provided to it by the Dodd-Frank Act. For example, on
August 18, 2011, the Commission approved two PCAOB rule changes: a
temporary PCAOB rule that established an interim program of inspection
of audits of broker-dealers,\279\ and a PCAOB rule change providing
that funds to cover the PCAOB's annual budget be allocated among
issuers, brokers, and dealers.\280\ In addition, as discussed below,
subsequent to the Commission's proposal to amend Rule 17a-5, the PCAOB
proposed attestation standards to establish requirements for examining
broker-dealer compliance reports and reviewing broker-dealer exemption
reports ``to align its attestation standards more closely with the
auditor's responsibilities under [the proposed amendments to Rule 17a-
5].'' \281\ The PCAOB concurrently proposed an auditing standard for
supplemental information accompanying audited financial statements that
would supersede the current standard.\282\ The auditing standard would
apply to supporting schedules broker-dealers must file under Rule 17a-
5, including schedules regarding the computation of net capital and the
customer reserve requirement and information related to the broker-
dealer's possession or control of customer assets.\283\ The PCAOB also
proposed amendments ``to tailor certain of its rules to the audits and
[independent public accountants] of broker-dealers.'' \284\
---------------------------------------------------------------------------

    \279\ See Public Company Accounting Oversight Board; Order
Approving Proposed Temporary Rule for an Interim Program of
Inspection Related to Audits of Brokers and Dealers, Exchange Act
Release No. 65163 (Aug. 18, 2011), 76 FR 52996 (Aug. 24, 2011).
    \280\ See Public Company Accounting Oversight Board; Order
Approving Proposed Board Funding Rules for Allocation of the Board's
Accounting Support Fee Among Issuers, Brokers, and Dealers, and
Other Amendments to the Board's Funding Rules, Exchange Act Release
No. 65162 (Aug. 18, 2011), 76 FR 52997 (Aug. 24, 2011).
    \281\ See PCAOB Proposing Release at 5.
    \282\ See PCAOB Proposed Auditing Standard for Supplemental
Information.
    \283\ Id. at 3.
    \284\ See Proposed Amendments to Conform the Board's Rules and
Forms to the Dodd-Frank Act and Make Certain Updates and
Clarifications, PCAOB Release No. 2012-002, PCAOB Rulemaking Docket
Matter No. 039 (Feb. 28, 2012).
---------------------------------------------------------------------------

2. Engagement of Accountant Requirements Prior to Today's Amendments
    Rule 17a-5 requires that a broker-dealer prepare and file certain
financial statements and supporting schedules in addition to the
balance sheet and income statement required under section 17(e)(1)(A)
of the Exchange Act.\285\ Before today's amendments, the financial
statements and supporting schedules were generally required to be
audited in accordance with GAAS by an independent public accountant
registered with the PCAOB.\286\
---------------------------------------------------------------------------

    \285\ See 17 CFR 240.17a-5(d).
    \286\ See 17 CFR 240.17a-5(g). An engagement to perform an audit
(or examination) of financial statements is designed to provide
reasonable assurance about whether the financial statements are free
of material misstatement. See, e.g., PCAOB Interim Auditing
Standard, AU Section 110 at ] .02. The term audit is defined in
section 110(1) of the Sarbanes-Oxley Act, as amended by the Dodd-
Frank Act, to mean ``an examination of the financial statements,
reports, documents, procedures, controls, or notices of an issuer,
broker, or dealer by an independent public accountant in accordance
with the rules of the [PCAOB] or the Commission, for the purpose of
expressing an opinion on the financial statements or providing an
audit report.''
---------------------------------------------------------------------------

    In addition to filing a report of the independent public accountant
covering the financial statements and supporting schedules, paragraph
(j) of Rule 17a-5 required the broker-dealer to file with the annual
audit a supplemental report prepared by the accountant (``material
inadequacy report'') that either: (1) Indicated that the accountant did
not find any material inadequacies; or (2) described any material
inadequacies in internal control the accountant found during the course
of the audit of the financial statements and supporting schedules and
any corrective action taken or proposed by the broker-dealer.\287\
---------------------------------------------------------------------------

    \287\ See 17 CFR 240.17a-5(j). Prior to today's amendments,
paragraph (g)(3) of Rule 17a-5 describes a material inadequacy in a
broker-dealer's accounting system, internal accounting controls,
procedures for safeguarding securities, and practices and procedures
to include any condition which has contributed substantially to or,
if appropriate corrective action is not taken, could reasonably be
expected to: (1) Inhibit a broker-dealer from promptly completing
securities transactions or promptly discharging its responsibilities
to customers, other broker-dealers or creditors; (2) result in
material financial loss; (3) result in material misstatements of the
broker-dealer's financial statements; or (4) result in violations of
the Commission's recordkeeping or financial responsibility rules to
an extent that could reasonably be expected to result in the
conditions described in (1) through (3) above. See 17 CFR 240.17a-
5(g)(3). In addition to the material inadequacy report, a broker-
dealer was required to file during certain periods a supplemental
report covered by an opinion of the independent public accountant on
the status of the broker-dealer's membership in SIPC. See 17 CFR
240.17a-5(e)(4). The Commission is amending this requirement as
discussed above in section II.C.4. of this release. Further, a
broker-dealer that computes net capital under the alternative model-
based standard in Appendix E to Rule 15c3-1 (17 CFR 240.15c3-1e) is
required to file a supplemental report of an independent public
accountant indicating the results of the accountant's review of the
internal risk management control system established and documented
by the broker-dealer in accordance with Rule 15c3-4 (17 CFR
240.15c3-4). See 17 CFR 240.17a-5(k). The Commission is not amending
this requirement today.
---------------------------------------------------------------------------

    For purposes of preparing the material inadequacy report, paragraph
(g)(1) of Rule 17a-5 required that the audit include a ``review'' of
the broker-dealer's accounting system, internal accounting control, and
procedures for safeguarding securities.\288\ Further, the accountant
was required to review the practices and procedures of the broker-
dealer in: (1) Making the periodic computations of aggregate
indebtedness and net capital under paragraph (a)(11) of Exchange Act
Rule 17a-3 and the reserve required by paragraph (e) of Rule 15c3-3;
\289\ (2) making the quarterly securities examinations, counts,
verifications, and comparisons and the recordation of differences
required by Rule 17a-13; \290\ (3) complying with the requirement for
prompt payment for securities under Regulation T of the Board of
Governors of the Federal Reserve System (``Regulation T''); \291\ and
(4) obtaining and maintaining physical possession or control of all
fully paid and excess margin securities of customers as required by
Rule 15c3-3.\292\ The scope of the independent public accountant's
procedures was required to be sufficient to provide ``reasonable
assurance'' that any material inadequacies existing at the date of the
examination in the broker-dealer's accounting system, internal
accounting control, and procedures for safeguarding securities as well
as in the practices and procedures described in items (1) through (4)
above would be disclosed.\293\
---------------------------------------------------------------------------

    \288\ See 17 CFR 240.17a-5(g)(1).
    \289\ See 17 CFR 240.17a-5(g)(1)(i).
    \290\ See 17 CFR 240.17a-5(g)(1)(ii).
    \291\ See 17 CFR 240.17a-5(g)(1)(iii). See also 12 CFR 220 et
seq. (Regulation T).
    \292\ See 17 CFR 240.17a-5(g)(1)(iv).
    \293\ See 17 CFR 240.17a-5(g)(1).
---------------------------------------------------------------------------

    The AICPA Broker-Dealer Audit Guide provided that the material
inadequacy report should address what the independent public accountant
concluded in its ``study'' of the adequacy of the broker-dealer's

practices and procedures in complying with the financial responsibility
rules in relation to the definition of material inadequacy as stated in
paragraph (g)(3) of Rule 17a-5.\294\ The issuance of a study is
relatively unique to broker-dealer audits, however, and while auditing
standards at one time referred to the performance of a study, current
auditing standards no longer contain such references.
---------------------------------------------------------------------------

    \294\ The material inadequacy report is addressed in the AICPA's
Audit & Accounting Guide: Brokers and Dealers in Securities (Sept.
1, 2011 ed.) (``AICPA Broker-Dealer Audit Guide''), which provides
that the report should: (1) Address what auditors concluded in their
study of the adequacy of the broker-dealer's practices and
procedures in complying with the Commission's financial
responsibility rules in relation to the definition of a material
inadequacy in Rule 17a-5; and (2) disclose material weaknesses in
internal control over financial reporting (including procedures for
safeguarding securities) that are revealed through auditing
procedures designed and conducted for the purpose of expressing an
opinion on the financial statements. See AICPA Broker-Dealer Audit
Guide at ] 3.77. The AICPA Broker-Dealer Audit Guide further
provides that if conditions believed to be material weaknesses are
found to exist or have existed during the year, the report should
disclose the nature of the weaknesses and the corrective action
taken or proposed to be taken by the broker-dealer. See AICPA
Broker-Dealer Audit Guide at ] 3.80. The AICPA Broker-Dealer Audit
Guide also provides sample reports ``on internal control required by
SEC Rule 17a-5(g)(1).'' See AICPA Broker-Dealer Audit Guide apps. C,
D, and F.
---------------------------------------------------------------------------

    Additional engagement of accountant requirements prior to today's
amendments were set forth in paragraphs (g) and (i) of Rule 17a-5.
Paragraph (g)(2) of Rule 17a-5 provided that, if the broker-dealer was
exempt from Rule 15c3-3, the independent public accountant must
ascertain that the conditions of the exemption were being complied with
as of the examination date and that no facts came to the independent
public accountant's attention to indicate that the exemption had not
been complied with during the period since the last examination.\295\
---------------------------------------------------------------------------

    \295\ See 17 CFR 240.17a-5(g)(2).
---------------------------------------------------------------------------

    Paragraph (i) of Rule 17a-5, before today's amendments, was titled,
``Accountant's reports--general provisions.'' \296\ Paragraph (i)(1) of
Rule 17a-5 provided that the accountant's report must be dated, signed
manually, indicate the city and state where issued, and identify the
financial statements and schedules covered by the report.\297\
Paragraph (i)(2) of Rule 17a-5 provided that the accountant's report
must state whether the audit was made in accordance with generally
accepted auditing standards; state whether the accountant reviewed the
procedures followed for safeguarding securities; and designate any
auditing procedures deemed necessary by the accountant under the
circumstances of the particular case which have been omitted, and the
reason for their omission.\298\ Further, the rule provided that
``[n]othing in this section shall be construed to imply authority for
the omission of any procedure which independent accountants would
ordinarily employ in the course of an audit made for the purpose of
expressing the opinions required under [Rule 17a-5].'' \299\
---------------------------------------------------------------------------

    \296\ See 17 CFR 240.17a-5(i).
    \297\ See 17 CFR 240.17a-5(i)(1).
    \298\ See 17 CFR 240.17a-5(i)(2).
    \299\ Id.
---------------------------------------------------------------------------

    Prior to today's amendments, paragraph (i)(3) of Rule 17a-5
provided that the accountant's report must state clearly the opinion of
the accountant: (i) with respect to the financial statements and
schedules covered by the report and the accounting principles and
practices; and (ii) as to the consistency of the application of the
accounting principles, or as to any changes in such principles that
have a material effect on the financial statements.\300\ Paragraph
(i)(4) provided that any matters to which the accountant took exception
must be clearly identified, the exception specifically and clearly
stated, and, to the extent practicable, the effect of each such
exception on the related financial statements given.\301\ Paragraph
(i)(5) of Rule 17a-5 provided that the terms audit (or examination),
accountant's report, and certified have the meanings given in Rule 1-02
of Regulation S-X (17 CFR 210.1-02).\302\
---------------------------------------------------------------------------

    \300\ See 17 CFR 240.17a-5(i)(3).
    \301\ See 17 CFR 240.17a-5(i)(4).
    \302\ See 17 CFR 240.17a-5(i)(5).
---------------------------------------------------------------------------

3. Amended Engagement of Accountant Requirements
i. Proposed Amendments
    The Commission proposed to substantially amend paragraph (g) and
remove paragraph (j) of Rule 17a-5, in part, to update the engagement
of the accountant requirements to address outdated or inconsistent
terminology in the rule.\303\ The proposed amendments to paragraph (g)
and removal of paragraph (j) of Rule 17a-5 would have eliminated the
requirement for the accountant to prepare and the broker-dealer to file
a material inadequacy report.\304\ In its place, the independent public
accountant would have been required to prepare, and the broker-dealer
would have been required to file, in addition to a report covering the
financial report, a report covering either the broker-dealer's
compliance report or exemption report, as applicable.\305\
Specifically, the Commission proposed to amend paragraph (g) of Rule
17a-5 to be titled ``Engagement of independent public accountant'' and
to require a broker-dealer required to file annual reports under
paragraph (d) of Rule 17a-5 to engage an independent public accountant,
unless the broker-dealer is subject to the exclusions in paragraphs
(d)(1) and (e)(1)(i) of Rule 17a-5. The independent public accountant,
as part of the engagement, would have been required to undertake to:
(1) Prepare a report based on an examination of the broker-dealer's
financial report in accordance with standards of the PCAOB; and (2)
prepare a report based on an ``examination'' of the assertions of the
broker-dealer in the compliance report in accordance with standards of
the PCAOB \306\ or to prepare a report based on a ``review'' of the
broker-dealer's exemption report in accordance with standards of the
PCAOB.\307\ This provision would have retained the requirement that the
financial statements and supporting schedules be audited by the
independent public accountant, so that the accountant would have
continued to be required to obtain ``reasonable assurance'' about
whether they were free of material misstatement, but would have changed

the audit standards from GAAS to standards of the PCAOB.\308\
---------------------------------------------------------------------------

    \303\ See Broker-Dealer Reports, 76 FR at 37578-37579. In
addition, the Commission proposed changing the title of paragraph
(g) from Audit objectives to Engagement of the independent public
accountant. Id. at 37606.
    \304\ Id. at 37578-37579.
    \305\ Id.
    \306\ An attest engagement designed to provide a high level of
assurance is referred to as an ``examination.'' See, e.g., PCAOB
Interim Attestation Standard, AT Section 101 at ] .54. For this type
of engagement, the accountant's conclusion will be expressed in the
form of an opinion. For example, the accountant's conclusion based
on an examination of an assertion could state that in the
accountant's opinion, [the assertion] is fairly stated in all
material respects. See, e.g., PCAOB Interim Attestation Standard, AT
Section 101 at ] .84. The proposed rule provided that the
examination and related report would apply to the broker-dealer's
``assertions'' in the compliance report (and therefore would not
apply to other items in the proposed compliance report; namely, a
statement as to whether the broker-dealer has established a system
of internal control and a description of instances of material non-
compliance, and material weaknesses over compliance with, the
financial responsibility rules).
    \307\ An attest engagement designed to provide a moderate level
of assurance is referred to as a ``review.'' See, e.g., PCAOB
Interim Attestation Standard, AT Section 101 at ]] .55, .89. For
this type of engagement, the accountant's conclusion will be
expressed, not in the form of an opinion, but in the form of
``negative assurance.'' See, e.g., PCAOB Interim Attestation
Standard, AT Section 101 at ] .68. For example, the accountant's
conclusion based on a review of an assertion could state that no
information came to the accountant's attention that indicates that
the assertion is not fairly stated in all material respects. See,
e.g., PCAOB Interim Attestation Standard, AT Section 101 at ] .88.
    \308\ See Broker-Dealer Reports, 76 FR at 37606. As stated
above, an engagement to perform an audit of financial statements is
designed to provide ``reasonable assurance'' about whether the
financial statements are free of material misstatement. See, e.g.,
PCAOB Interim Attestation Standard, AT Section 101 at ] .54.
---------------------------------------------------------------------------

    The Commission proposed making conforming amendments to paragraph
(i) of Rule 17a-5, substituting the words ``examinations'' and
``reviews'' for the word ``audits,'' substituting the words ``standards
of the PCAOB'' for ``generally accepted auditing standards,''
substituting ``annual reports'' for ``financial statements,'' and
changing the title to ``Reports prepared by the independent public
accountant.'' The Commission also proposed deleting paragraph (i)(5) of
Rule 17a-5, which provided that the terms ``audit,'' ``examination,''
``accountant's report,'' and ``certified'' have the meanings given in
Rule 1-02 of Regulation S-X. As proposed, paragraph (i)(1) of Rule 17a-
5 would have provided that the independent public accountant's reports
must: be dated; be signed manually; indicate the city and state where
issued; and identify without detailed enumeration the items covered by
the reports. Paragraph (i)(2) of Rule 17a-5 would have provided that
the accountant's report must state whether the examination or review
was made in accordance with standards of the PCAOB and must designate
any examination, and, if applicable, review procedures deemed necessary
by the independent public accountant under the circumstances of the
particular case that have been omitted, and the reason for their
omission. Further, the rule would have provided that ``[n]othing in
this section shall be construed to imply authority for the omission of
any procedure that independent public accountants would ordinarily
employ in the course of an examination or review made for the purpose
of expressing the opinions or statement required under [Rule 17a-5].''
Paragraph (i)(3) of Rule 17a-5 would have provided that the independent
public accountant's reports must state clearly the opinion of the
independent public accountant: (i) with respect to the financial report
and the accounting principles and practices reflected therein and the
compliance report; and (ii) with respect to the financial report, as to
the consistency of the application of the accounting principles, or as
to any changes in such principles that have a material effect on the
financial statements. Paragraph (i)(4) of Rule 17a-5 would have
provided that any matters to which the independent public accountant
takes exception must be clearly identified, the exception thereto
specifically and clearly stated, and, to the extent practicable, the
effect of each such exception on any related items contained in the
annual reports.
    As stated above, after the Commission proposed the amendments to
Rule 17a-5, the PCAOB issued proposed standards that ``would establish
requirements for examining the assertions in a broker's or dealer's
compliance report and reviewing a broker's or dealer's assertion in the
exemption report.'' \309\ The PCAOB stated that the proposed standards
were ``tailored to the requirements'' in Rule 17a-5 as proposed to be
amended by the Commission.\310\
---------------------------------------------------------------------------

    \309\ See PCAOB Proposing Release at 5.
    \310\ Id.
---------------------------------------------------------------------------

ii. Comments
    The Commission received several comments regarding the proposed
revisions to the independent accountant engagement requirements in Rule
17a-5.\311\ One commenter stated that GAAS should be used for audits of
non-carrying broker-dealers; or, in the alternative, that the
Commission should delay the effective date for the requirement that the
audit be conducted in accordance with PCAOB standards for smaller
broker-dealers until one year after the approval of the
amendments.\312\ A second commenter stated that PCAOB standards should
apply only for broker-dealers ``permanently subject to PCAOB
inspection'' and that the Commission should not require that audits of
broker-dealers be performed in accordance with PCAOB standards for non-
issuer broker-dealers until the PCAOB determines which non-issuer
broker-dealers will be subject to its permanent inspection
program.\313\
---------------------------------------------------------------------------

    \311\ See, e.g., ABA Letter; AICPA Letter; Citrin Letter; E&Y
Letter; Van Kampen/Invesco Letter.
    \312\ See Citrin Letter. The Commission also received many
comments seeking additional time to transition to the final rules.
Those comments are discussed below in section V. of this release.
    \313\ See AICPA Letter.
---------------------------------------------------------------------------

    One commenter noted that the proposing release states that broker-
dealers will be required to file a report by the accountant that
``addresses'' the assertions in the compliance report,\314\ and stated
that the Commission should provide more guidance on what an accountant
must address, as ``nowhere in the Release or in the proposed rules is
there guidance as to what `addresses' means or entails.'' \315\ This
commenter further stated that the Commission ``presumably'' will rely
on PCAOB rules, and suggested that final rules regarding the
accountant's obligations with respect to its examination of the
compliance report should be deferred until after a comment period of at
least 60 days after the PCAOB rules are finalized or the Commission
amends its proposal to include specifics as to what ``address'' means
and what type of review is required by the accountant.\316\ The
commenter also stated that the requirement should not be effective
unless the AICPA Broker-Dealer Audit Guide is revised and updated.\317\
One commenter asked what was expected of the auditor with respect to
the books and records assertion and stated that a separate opinion on
this assertion may entail more detailed procedures as to the source of
the information.\318\
---------------------------------------------------------------------------

    \314\ See Broker-Dealer Reports, 76 FR at 37575.
    \315\ See ABA Letter.
    \316\ Id.
    \317\ Id. As stated below, AICPA guidance will no longer be
applicable once standards of the PCAOB apply to broker-dealer annual
reports.
    \318\ See Grant Thornton Letter.
---------------------------------------------------------------------------

    Another commenter stated that a review engagement should not be
employed for the exemption report because inquiry and observation would
not provide sufficient evidence regarding a broker-dealer's assertion
that it is exempt from the requirements of Rule 15c3-3 and stated that,
under the PCAOB's interim attestation standards, an auditor should not
accept an engagement to perform a ``review'' level of service related
to an entity's compliance with specified requirements or an assertion
with regard to that compliance.\319\ As an alternative, this commenter
suggested an ``agreed-upon procedures'' approach addressing the results
of procedures specified by the Commission or the performance of an
examination engagement if suitable criteria were developed.\320\
Another commenter stated that the benefit of receiving an audit report
covering the exemption report would not justify the cost.\321\
Similarly, a commenter stated that the exemption report should be
replaced with a box to check on the FOCUS Report as the auditor
attestation provided no added benefit.\322\
---------------------------------------------------------------------------

    \319\ See E&Y Letter.
    \320\ Id.
    \321\ See Citrin Letter.
    \322\ See Angel Letter.
---------------------------------------------------------------------------

    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.\323\ One commenter stated that
due to the reliance placed on the financial books and records to

calculate net capital, it will not be feasible to attest to the
effectiveness of internal control over the financial responsibility
rules without also attesting to internal control over financial
reporting.\324\ The commenter stated that, accordingly, it is necessary
to include internal control over financial reporting within the scope
of the rule. The commenter stated its understanding that accountants
expect to include internal control over financial reporting in their
attestation scope over the financial responsibility rules, and that the
process will include documenting all existing processes and engaging
internal audit to validate the effectiveness of the procedures
implemented through procedural walkthroughs and control testing to
validate management's assertions.\325\ This commenter also stated its
belief that independent public accountants will need ``to include an
attestation of the additional in scope processes within the scope of
their audit work in order to comply with PCAOB requirements.'' \326\
---------------------------------------------------------------------------

    \323\ See Deloitte Letter; KPMG Letter; PWC Letter.
    \324\ See Van Kampen/Invesco Letter.
    \325\ Id.
    \326\ Id.
---------------------------------------------------------------------------

    As noted above in section II.B.4.ii. of this release, with respect
to the independent public accountant's review of the exemption reports,
one commenter stated that, for example, 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 should not ``warrant the `material modification'
of a broker-dealer's Exemption Report.'' \327\ 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.''
\328\
---------------------------------------------------------------------------

    \327\ See SIFMA letter.
    \328\ See CAI Letter.
---------------------------------------------------------------------------

iii. The Final Rule
    The Commission is adopting amendments to the engagement of the
accountant requirements in Rule 17a-5 substantially as proposed, except
for revisions, as discussed in detail below, to clarify the rule's
requirements and to make technical changes. Paragraph (g) of Rule 17a-5
as adopted provides that the independent public accountant engaged by
the broker-dealer to provide reports on the financial report and either
the compliance report or exemption report must, as part of the
engagement undertake to: (1) Prepare a report based on an examination
of the broker-dealer's financial report in accordance with standards of
the PCAOB; and (2) prepare a report based on an examination of certain
enumerated statements of the broker-dealer in the compliance report
\329\ in accordance with standards of the PCAOB or prepare a report
based on a review of the statements in the broker-dealer's exemption
report in accordance with standards of the PCAOB. Additionally, as
proposed, the amendments delete paragraph (j) of Rule 17a-5, which, as
explained above, required that the broker-dealer file with the annual
audit report a material inadequacy report, as well as provisions in
paragraph (g) of Rule 17a-5 requiring that the audit be conducted in
accordance with GAAS and addressing the accountant's review for
material inadequacies.
---------------------------------------------------------------------------

    \329\ As discussed above in section II.B.3. of this release, the
final rule does not use the term assertion--the assertions contained
in the proposal are now referred to as statements. These changes are
not intended to be substantive. Paragraph (g) of Rule 17a-5
specifies that the accountant prepare a report based on an
examination of certain statements enumerated in the rule. Similar to
the proposal, the statements subject to the examination do not
include a statement as to whether the broker-dealer has established
a system of internal control or a description of instances of non-
compliance with certain financial responsibility rules.
---------------------------------------------------------------------------

    Various commenters suggested that GAAS instead of PCAOB standards
should apply for engagements of accountants with respect to certain
broker-dealer reports, such as reports of non-carrying broker-
dealers.\330\ The Commission believes that requiring GAAS for audits of
broker-dealers that are exempt from Rule 15c3-3 would not be consistent
with the provisions of the Dodd-Frank Act that provide the PCAOB with
explicit authority to establish standards with regard to audits of
broker-dealer reports filed with the Commission.\331\ These provisions
enable the PCAOB to exercise its standard-setting authority over audits
of broker-dealers registered with the Commission. The change from GAAS
to PCAOB auditing standards will facilitate the Commission's regulatory
oversight authority because the Commission has direct oversight
authority over the PCAOB, including the ability to approve or
disapprove the PCAOB's rules and standards. The Commission also has
greater confidence in the quality of audits conducted by an independent
public accountant registered with, and subject to regular inspection
by, the PCAOB.\332\ Further, as the PCAOB develops and implements an
inspection program of broker-dealer audits as contemplated by the Dodd-
Frank Act, that program will include inspection of, among other things,
``registered public accounting firms' current compliance with laws,
rules, and standards in performing audits of brokers and dealers.''
\333\ The requirement that all broker-dealer independent public
accountants comply with the standards established by the PCAOB should
facilitate the development and implementation of its permanent
inspection program, as contemplated by the Dodd-Frank Act.
---------------------------------------------------------------------------

    \330\ See AICPA Letter; Citrin Letter.
    \331\ See Public Law 111-203 Sec.  982. For example, section
982(a) of the Dodd-Frank Act added section 110 to the Sarbanes-Oxley
Act, which contains definitions of terms such as audit, audit
report, and professional standards. These definitions apply to
audits, audit reports, and professional standards with respect to
audits of broker-dealers as well as audits of issuers. In addition,
section 982(b) of the Dodd-Frank Act amended section 101 of the
Sarbanes-Oxley Act to substitute the words ``issuers, brokers, and
dealers'' for the word ``issuers.''
    \332\ See Custody of Funds or Securities of Clients by
Investment Advisers, 75 FR at 1460.
    \333\ See Temporary Rule for an Interim Program of Inspection
Related to Audits of Brokers and Dealers, PCAOB Release No. 2011-
001, PCAOB Rulemaking Docket Matter No. 32, 1 (June 14, 2011).
---------------------------------------------------------------------------

    As noted above, the PCAOB has proposed an auditing standard for
supplemental information accompanying audited financial statements,
including the supporting schedules broker-dealers must file as part of
the financial report.\334\ The PCAOB stated that a primary factor that
led it to reexamine its requirements regarding supplemental information
was the Commission's proposal to amend the reporting requirements of
Rule 17a-5.\335\ In addition, as noted above, the PCAOB has proposed
specific attestation standards for examining compliance reports and
reviewing exemption reports. The PCAOB's proposing release noted that
the proposed standards ``are tailored to the requirements in SEC
Proposed Rule 17a-5.'' \336\ The proposed standards, if adopted, would
establish a single and broker-dealer-specific approach to examining
compliance reports and reviewing exemption reports. This should provide
greater clarity as to procedures an independent public accountant
should use in examining a compliance report and reviewing an exemption
report.
---------------------------------------------------------------------------

    \334\ See PCAOB Proposed Auditing Standard for Supplemental
Information.
    \335\ Id. at 2-3.
    \336\ See PCAOB Proposing Release at 5.
---------------------------------------------------------------------------

    With respect to comments suggesting that PCAOB standards should
apply only to auditors of broker-dealers ``permanently subject to PCAOB
inspection,'' \337\ the PCAOB has not exempted the audits by
independent

public accountants of any class of broker-dealer from the PCAOB's
permanent inspection program.\338\ In fact, the PCAOB has established
an interim inspection program for all broker-dealer audits by
independent public accountants that will ``allow the Board to begin
inspections of relevant audits and auditors and provide a source of
information to help guide decisions about the scope and elements of a
permanent program.'' \339\ The PCAOB stated that it did not intend ``to
postpone all use of its new inspection authority until after those
judgments were made.'' \340\
---------------------------------------------------------------------------

    \337\ See AICPA Letter.
    \338\ See Public Company Accounting Oversight Board: Order
Approving Proposed Temporary Rule for an Interim Program of
Inspection Related to Audits of Brokers and Dealers, Exchange Act
Release No. 65163 (Aug. 18, 2011), 76 FR at 52996 (Aug. 24, 2011).
    \339\ Id. at 52997.
    \340\ Id.
---------------------------------------------------------------------------

    At this time, there is no reason to expect that any type of broker-
dealer audit will be exempt from the PCAOB's permanent inspection
program, and any PCAOB determination to exempt broker-dealer audits
from the PCAOB's permanent inspection program must be approved by the
Commission. Therefore, notwithstanding any such exemption, paragraph
(g) of Rule 17a-5 is amended to require that broker-dealer independent
public accountants prepare reports covering the financial report and
compliance report or exemption report in accordance with standards of
the PCAOB.
    On August 20, 2012, the PCAOB published its first report on the
progress of the interim inspection program.\341\ The report contains
observations from inspections of portions of 23 broker-dealer audits
conducted by ten independent public accounting firms that were all
conducted in accordance with GAAS.\342\ The inspections did not exclude
any broker-dealer audits from being eligible for selection.\343\ PCAOB
staff identified deficiencies in all of the audits inspected.\344\ For
example, as to all of the 14 audits of broker-dealers that claimed an
exemption from Rule 15c3-3, the staff stated that the accountant ``did
not perform sufficient procedures to ascertain that the broker or
dealer complied with the conditions of the exemption,'' \345\ and in 21
of the 23 audits, that the accountant ``failed to perform sufficient
audit procedures to obtain reasonable assurance that any material
inadequacies found to exist since the date of the last examination . .
. would have been disclosed in the accountant's supplemental report.''
\346\ The deficiencies noted in the PCAOB's report on the progress of
the interim inspection program provide further support for the
amendments that the Commission is adopting today to establish the
foundation for the PCAOB's development of standards that are tailored
to Rule 17a-5, and to strengthen and facilitate consistent compliance
with broker-dealer audit and reporting requirements.
---------------------------------------------------------------------------

    \341\ See PCAOB, Report on the Progress of the Interim
Inspection Program Related to Audits of Brokers and Dealers, PCAOB
Release No. 2012-005 (August 20, 2012) (``PCAOB Inspection
Report'').
    \342\ Id. at ii.
    \343\ Id. at 8.
    \344\ Id. at ii.
    \345\ Id. at iii.
    \346\ Id.
---------------------------------------------------------------------------

    Several commenters suggested that the Commission delay the
applicability of these requirements because, among other things, PCAOB
standards regarding broker-dealer audits, including standards that
apply to compliance reports and exemption reports, will not be final
when these rule amendments are adopted.\347\ In response, as discussed
below in section V. of this release, the Commission is delaying the
effective dates of most of the rule amendments. In accordance with the
effective dates, broker-dealers must file compliance reports or
exemption reports, as applicable, and broker-dealers must file reports
of independent public accountants covering compliance reports or
exemption reports in accordance with Rule 17a-5 as amended, for fiscal
years ending on or after June 1, 2014. In the interim, broker-dealers
must continue to file material inadequacy reports in accordance with
the provisions of Rule 17a-5 as they existed before today's amendments.
Broker-dealer independent public accountants must prepare reports based
on an examination of broker-dealer financial reports in accordance with
PCAOB standards for fiscal years ending on or after June 1, 2014. In
the interim, audits of broker-dealer financial statements filed with
the Commission under Rule 17a-5 should continue to be understood to
mean auditing standards generally accepted in the U.S., plus any
applicable rules of the Commission.\348\ The June 1, 2014 effective
date should provide sufficient time for the PCAOB to finalize, subject
to Commission approval, the standards for broker-dealer audits and for
broker-dealers and their independent public accountants to prepare to
comply with the new requirements and standards.
---------------------------------------------------------------------------

    \347\ See, e.g., CAQ Letter; Deloitte Letter; Grant Thornton
Letter; KPMG Letter; McGladrey Letter.
    \348\ See Commission Guidance Regarding Auditing, Attestation,
and Related Professional Practice Standards Related to Brokers and
Dealers, Exchange Act Release No. 62991 (Sept. 24, 2010), 75 FR
60616, 60617 (Oct. 1, 2010).
---------------------------------------------------------------------------

    As noted above, one commenter stated the Commission should provide
more guidance on what an independent public accountant must address,
and that the requirement for PCAOB standards should not be effective
unless the AICPA Broker-Dealer Audit Guide is revised and updated.\349\
Another commenter sought clarification on what was expected of the
auditor with respect to the books and records assertion.\350\ In
response to these comments, the Commission notes that the PCAOB's
proposed standards with respect to the examination of the compliance
report by the independent public accountant address, among other
things: (1) The objective of the examination; (2) the relationship
between the examination engagement and the audit of the financial
report; (3) considerations for broker-dealers with multiple divisions
or branches; (4) identifying risks of material non-compliance; (5)
testing controls over compliance; (6) performing compliance tests; (7)
testing information used to assert compliance; (8) evaluating the
results of the examination procedures; (9) subsequent events; (10)
obtaining a representation letter; (11) communication requirements;
(12) reporting on the examination engagement; (13) the examination
report date; and (14) examination report modifications.\351\ The
PCAOB's proposed standards with respect to the review of the exemption
report by the independent public accountant address, among other
things: (1) The objective of the review; (2) the relationship between
the review engagement and the audit of the financial report; (3) the
review procedures; (4) evaluating the results of the examination
procedures; (5) obtaining a representation letter; (6) communication
requirements; (7) reporting on the review engagement; (8) the review
report date; and (9) review report modifications.\352\ The Commission
expects that the final standards of the PCAOB, which are subject to
Commission approval, will provide sufficient guidance to independent
public accountants performing examinations of compliance reports and
reviews of exemption reports.
---------------------------------------------------------------------------

    \349\ See ABA Letter.
    \350\ See Grant Thorton Letter.
    \351\ See PCAOB Proposing Release app. 1.
    \352\ See PCAOB Proposing Release app. 2.
---------------------------------------------------------------------------

    In response to the comment that the requirements with respect to
the compliance reports and exemption reports should not be effective
unless

the AICPA Broker-Dealer Audit Guide is revised and updated, as stated
above, once adopted, only the standards of the PCAOB apply to broker-
dealer annual reports. The PCAOB has proposed standards with respect to
the examination of the compliance report and the review of the
exemption report and it is expected that final standards will be in
place before the audit requirements with respect to the compliance
report and the exemption report are effective. Consequently, there is
no need to wait for the AICPA Broker-Dealer Audit Guide to be updated.
    As noted above, several commenters requested clarity about the
interaction between material weaknesses in internal control over
financial reporting and material weaknesses in internal control over
compliance with the financial responsibility rules.\353\ Additionally,
one commenter stated that due to the reliance placed on the financial
books and records of the broker-dealer, it will not be feasible for the
independent public accountant to attest to the effectiveness of
internal control over the financial responsibility rules without also
attesting to internal control over financial reporting.\354\ As
discussed above in section II.B.3.iii. of this release, although a
broker-dealer is required to state in the compliance report that the
information it used to state whether it was in compliance with Rule
15c3-1 and paragraph (e) of Rule 15c3-3 was derived from its books and
records, the final rule does not require that the broker-dealer include
a statement regarding the effectiveness of its internal control over
the accuracy of its books and records, nor does it require that the
independent public accountant attest to the effectiveness of internal
control over the accuracy of the broker-dealer's books and records.
Additionally, under the final rule, the independent public accountant
is not required to opine on the effectiveness of the broker-dealer's
internal control over financial reporting. However, the independent
public accountant's existing obligation to gain an understanding and
perform appropriate procedures relative to the broker-dealer's internal
control over financial reporting, as a necessary part of the
independent public accountant's financial report audit, remains
unchanged.\355\ Further, as discussed above in section II.B.3.iii. of
this release, 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 controls and procedures.
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.
---------------------------------------------------------------------------

    \353\ See Deloitte Letter; KPMG Letter; PWC Letter.
    \354\ See Van Kampen/Invesco Letter.
    \355\ See PCAOB Auditing Standard, AS No. 12 (for audits of
fiscal years beginning on or after December 15, 2010).
---------------------------------------------------------------------------

    As noted above, one commenter stated that a review engagement
should not be employed for the exemption report, because an
accountant's inquiry and observation would not provide sufficient
evidence regarding a broker-dealer's assertion that it is exempt from
Rule 15c3-3, and under the PCAOB's attestation standards, an auditor
should not accept an engagement to perform a ``review'' engagement
related to an entity's compliance with specified requirements.\356\ As
an alternative, this commenter suggested an ``agreed-upon procedures''
approach or an examination engagement.\357\
---------------------------------------------------------------------------

    \356\ See E&Y Letter.
    \357\ Id.
---------------------------------------------------------------------------

    The PCAOB's attestation standards currently provide that an
accountant should not accept an engagement to perform a review of an
entity's compliance with specified requirements or about the
effectiveness of an entity's internal control over compliance, and that
an agreed upon procedures engagement be considered as an
alternative.\358\ Irrespective of the PCAOB's current standards, Rule
17a-5, as amended, provides that the broker-dealer engage an
independent public accountant to perform a review of the exemption
report. Moreover, in July 2011, as part of its proposed standards for
attestation engagements related to broker-dealer compliance reports or
exemption reports, the PCAOB proposed replacing the provision cited by
the commenter with the following: ``When a practitioner is engaged to
perform a review engagement on assertions made by a broker or dealer in
an exemption report that is prepared pursuant to SEC Proposed Rule 17a-
5, the practitioner must conduct the review engagement pursuant to
Proposed Attestation Standard, Review Engagements Regarding Exemption
Reports of Brokers and Dealers.'' \359\ In addition, as discussed
above, the PCAOB has proposed specific standards for an accountant to
perform a review of the exemption report.\360\ The PCAOB's final
standards, which must be approved by the Commission, are intended by
the PCAOB to clarify the procedures an independent public accountant
will need to perform in a review of an exemption report.\361\
---------------------------------------------------------------------------

    \358\ See PCAOB Interim Attestation Standard, AT Section 601 at
] 7.
    \359\ See PCAOB Proposing Release app. 3 at A3-4. The PCAOB's
attestation standards currently provide that an accountant should
not accept an engagement to perform a review of an entity's
compliance with specified requirements or about the effectiveness of
an entity's internal control over compliance or an assertion
regarding those items. See PCAOB Interim Attestation Standard, AT
Section 601 at ] 7.
    \360\ See PCAOB Proposing Release app. 2.
    \361\ Id.
---------------------------------------------------------------------------

    In response to the comment that a review engagement should not be
employed for the exemption report because inquiry and observation would
not provide sufficient evidence,\362\ the independent public accountant
would be able to obtain the moderate level of assurance contemplated by
the required review through a combination of procedures that the
accountant would perform in connection with the financial audit
currently required under Rule 17a-5 and certain inquiries and other
procedures specifically targeting the exemption report. Also, the
PCAOB's proposal includes specific requirements for a review engagement
regarding exemption reports of brokers and dealers. In addition to
inquiry and observation, the PCAOB's proposal states that ``in
performing the review engagement, the auditor should . . . [e]valuate
whether the evidence obtained and the results of the procedures
performed in the audit of the financial statements and supplemental
information corroborate or contradict the broker's or dealer's
assertion regarding compliance with the exemption conditions.'' \363\
Additionally, the auditor should ``[p]erform other procedures as
necessary in the circumstances to obtain moderate assurance.'' \364\
The PCAOB's final standards will provide clarity on the procedures to
be performed by the independent public accountant to obtain a moderate
level of assurance to form a conclusion with respect to the review of
the exemption report.\365\
---------------------------------------------------------------------------

    \362\ See E&Y Letter.
    \363\ See PCAOB Proposing Release app. 2.
    \364\ Id.
    \365\ Id.
---------------------------------------------------------------------------

    The commenter's suggestion to use an ``agreed-upon procedures''
engagement for the exemption report was considered. The final rule,
however, requires a review engagement as proposed. Under an ``agreed-
upon procedures'' engagement, the independent public accountant is

engaged by a client to issue a report of findings based on specific
procedures performed on subject matter that the specified parties
believe are appropriate.\366\ Additionally, in an ``agreed-upon
procedures'' engagement, the independent public accountant does not
perform an examination or a review, and does not provide an opinion or
negative assurance. Thus, no conclusion would be rendered as to the
broker-dealer's statement that it met certain exemption provisions in
Rule 15c3-3.
---------------------------------------------------------------------------

    \366\ See PCAOB Interim Attestation Standard, AT Section 201 at
] .03.
---------------------------------------------------------------------------

    In addition to the commenter advocating an ``agreed-upon
procedures'' standard,\367\ a second commenter stated that the cost
``would not justify the need'' for an audit report covering the
exemption report \368\ and a third commenter stated that the exemption
report should be replaced with a box to check on the FOCUS Report as
the auditor attestation provided no added benefit.\369\ In response to
all these comments, the Commission notes that previously Rule 17a-5
required that if a broker-dealer is exempt from Rule 15c3-3, the
independent public accountant is required to ascertain whether the
conditions of the exemption were being complied with and that no facts
came to the accountant's attention to indicate that the exemption had
not been complied with.\370\ Consequently, the rule previously required
the independent public accountant to reach a conclusion with respect to
a broker-dealer's claimed exemption from Rule 15c3-3. The Commission
believes that the rule should continue to require a conclusion from the
independent public accountant on the broker-dealer's claimed exemption
from Rule 15c3-3 because of the importance of safeguarding customer
securities and cash. Consequently, the Commission does not believe that
it would be appropriate to use a lower standard (i.e., the agreed-upon
procedures standard) or to have no requirement for the independent
public accountant to perform any work with respect to the exemption
report. Moreover, because the independent public accountant was
previously required to render a conclusion with respect to the broker-
dealer's claimed exemption from Rule 15c3-3, the exemption report
review should not result in significant incremental cost over the
existing requirement.
---------------------------------------------------------------------------

    \367\ See E&Y Letter.
    \368\ See Citrin Letter.
    \369\ See Angel Letter.
    \370\ See 17 CFR 240.17a-5(g)(2).
---------------------------------------------------------------------------

    As noted above, two commenters raised concerns that minor
exceptions to meeting the exemption provisions of paragraph (k) of Rule
15c3-3 could result in the independent public accountant becoming aware
of material modifications that should be made to the statement in the
exemption report.\371\ Under PCAOB standards for attestation
engagements, the independent public accountant's review report on a
statement in an exemption report would be required to include a
statement about whether the accountant is aware of any material
modifications that should be made to the statement in the exemption
report in order for it to be fairly stated in all material
respects.\372\ As discussed above in section II.B.4.iii. of this
release, the exemption report requirements have been modified from the
proposal so that a broker-dealer must either state 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. Consequently, a broker-dealer that had
exceptions will state that fact in the exemption report and describe
the exceptions. Under PCAOB standards, if the statement is fairly
stated in all material respects, including descriptions of any
exceptions, the broker-dealer's independent public accountant would not
need to state that the accountant is aware of any material
modifications that should be made to the statement.\373\
---------------------------------------------------------------------------

    \371\ See CAI Letter; SIFMA letter.
    \372\ See PCAOB Interim Attestation Standard, AT Section 101 at
] .90. See also PCAOB Proposing Release app. 2 at ] 11 (``The
auditor should evaluate the identified instances of non-compliance
with the exemption conditions to determine whether the instances of
non-compliance, individually or in combination, cause the broker's
or dealer's assertion not to be fairly stated, in all material
respects. If the broker's or dealer's assertion is not fairly
stated, in all material respects, the auditor should: (a) Modify the
review report . . . and (b) evaluate the effect of the matter on the
audit of the financial statements and supplemental information.'').
    \373\ See PCAOB Interim Attestation Standard, AT Section 101 at
] .67 (stating that in expressing its conclusion, an independent
public accounting ``should consider an omission or a misstatement to
be material if the omission or misstatement--individually or when
aggregated with others--is such that a reasonable person would be
influenced by the omission or misstatement.'').
---------------------------------------------------------------------------

    The Commission did not receive comments regarding the proposed
amendments to paragraph (i) of Rule 17a-5. However, the final rule has
been revised from the proposal for clarity and consistency with the
other amendments to Rule 17a-5. The title of the rule has been modified
from the proposal to add a citation for clarity. As adopted, the title
is, ``Reports of the independent public accountant required under
paragraph (d)(1)(i)(C) of [Rule 17a-5].'' As adopted, paragraph (i)(1)
of Rule 17a-5 provides, as proposed, that the independent public
accountant's reports must: Be dated; be signed manually; indicate the
city and state where issued; and identify without detailed enumeration
the items covered by the reports.
    Paragraph (i)(2) of Rule 17a-5, as adopted, is also consistent with
the proposal except that the word ``Identify'' is substituted for the
word ``Designate'' for clarity and the phrase ``opinions or
conclusions'' is substituted for the phrase ``opinions or statement''
because as explained above, consistent with auditing standards, a
review engagement will not result in an opinion, but in the
accountant's conclusion in the form of ``negative assurance''--for
example, a conclusion that no information came to the accountant's
attention that indicates that a statement is not fairly stated in all
material respects.\374\ The rule therefore provides that the
independent public accountant's reports must: (i) State whether the
examinations or review, as applicable, were made in accordance with
standards of the PCAOB; (ii) identify any examination and, if
applicable, review procedures deemed necessary by the independent
public accountant under the circumstances of the particular case that
have been omitted and the reason for their omission. The rule also
provides that: ``[n]othing in this section may be construed to imply
authority for the omission of any procedure that independent public
accountants would ordinarily employ in the course of an examination or
review made for the purpose of expressing the opinions or conclusions
required under [Rule 17a-5].''
---------------------------------------------------------------------------

    \374\ Id. at ]] .68, .88.
---------------------------------------------------------------------------

    Paragraph (i)(3) of Rule 17a-5, as adopted, is re-organized for
clarity. Specific reference has been added to those statements in the
compliance report that the accountant must examine, consistent with
other amendments to Rule 17a-5 (e.g., the amendments to paragraph
(g)(2)(i) of Rule 17a-5 regarding the engagement of the accountant to
prepare a report based on the examination of specified statements in
the compliance report). In addition, a subparagraph is added to include
a reference to the exemption

report.\375\ The rule provides that the independent public accountant's
reports must state clearly: (i) The opinion of the independent public
accountant with respect to the financial report required under
paragraph (d)(1)(i)(A) of Rule 17a-5 and the accounting principles and
practices reflected in that report; (ii) the opinion of the independent
public accountant with respect to the financial report required under
paragraph (d)(1)(i)(A) of Rule 17a-5, as to the consistency of the
application of the accounting principles, or as to any changes in those
principles, that have a material effect on the financial statements;
and (iii) either (A) the opinion of the independent public accountant
with respect to the statements required under paragraphs
(d)(3)(i)(A)(2), (3), (4), and (5) of Rule 17a-5 in the compliance
report required under paragraph (d)(1)(i)(B)(1) of Rule 17a-5, or (B)
the conclusion of the independent public accountant with respect to the
statements required under paragraphs (d)(4)(i), (ii), and (iii) of Rule
17a-5. The specific references to the compliance report and exemption
report in paragraph (i)(3) are intended to provide a complete
description of what must be contained in the report of the independent
public accountant under current attestation standards, which require a
conclusion in the case of an examination to be expressed in the form of
an opinion and a conclusion in the case of a review that is not
expressed in the form of an opinion, but in the form of ``negative
assurance.'' \376\
---------------------------------------------------------------------------

    \375\ As proposed, paragraph (i)(3) did not contain a reference
to the exemption report. See Broker-Dealer Reports, 76 FR at 37607.
The final rule makes clear that the auditor's conclusion must be
included in the independent public accountant's report covering the
exemption report.
    \376\ As noted above, the accountant's conclusion in an
examination engagement will be expressed in the form of an opinion.
For example, the accountant's conclusion based on an examination of
an assertion could state that in the accountant's opinion, the
assertion is fairly stated in all material respects. See, e.g.,
PCAOB Interim Attestation Standard, AT Section 101 at ] .84. The
accountant's conclusion in a review engagement will be expressed,
not in the form of an opinion, but in the form of ``negative
assurance.'' See, e.g., PCAOB Interim Attestation Standard, AT
Section 101 at ] .68. For example, the accountant's conclusion based
on a review of an assertion could state that no information came to
the accountant's attention that indicates that the assertion is not
fairly stated in all material respects. See, e.g., PCAOB Interim
Attestation Standard, AT Section 101 at ] .88.
---------------------------------------------------------------------------

    Paragraph (i)(4) of Rule 17a-5 has been modified from the proposal
to add a reference to paragraph (d) to make it more clear that the
annual reports referenced in the paragraph are the financial report,
compliance report, and exemption report prescribed in paragraph (d). In
addition--in the interest of using ``plain English'' in the
Commission's rules--the word ``must'' has been substituted for the word
``shall'' and the word ``thereto'' has been eliminated. The rule as
adopted therefore provides that ``[a]ny matters to which the
independent public accountant takes exception must be clearly
identified, the exceptions must be specifically and clearly stated,
and, to the extent practicable, the effect of each such exception on
any related items contained in the annual reports required under
paragraph (d) of [Rule 17a-5] must be given.''

E. PCAOB Registration of Independent Public Accountant--Paragraph
(f)(1) of Rule 17a-5

    Prior to today's amendments, paragraph (f)(1) of Rule 17a-5 was
titled ``Qualification of accountants'' and provided that: ``The
Commission will not recognize any person as a certified public
accountant who is not duly registered and in good standing as such
under the laws of his place of residence or principal office.'' \377\
Paragraph (f)(3) of Rule 17a-5 provided that the accountant ``shall be
independent in accordance with the provisions of Sec.  210.2-01 (b) and
(c) of this chapter'' and, paragraph (e)(1)(i) of Rule 17a-5 provided
that the accountant ``shall be in fact independent as defined in
paragraph (f)(3) of this section.'' \378\
---------------------------------------------------------------------------

    \377\ See 17 CFR 240.17a-5(f)(1).
    \378\ See 17 CFR 240.17a-5(f)(3).
---------------------------------------------------------------------------

    As discussed above, section 17(e)(1)(A) of the Exchange Act, as
amended by the Dodd-Frank Act, requires registered broker-dealers to
annually file financial statements with the Commission certified by
``an independent public accounting firm, or by a registered public
accounting firm if the firm is required to be registered under the
Sarbanes-Oxley Act of 2002.'' Accordingly, the Commission proposed
amending paragraph (f)(1) to provide that: ``The independent public
accountant must be qualified and independent in accordance with Sec.
210.2-01 of this chapter and, in addition, the independent public
accountant must be registered with the Public Company Accounting
Oversight Board if required by the Sarbanes-Oxley Act of 2002.'' \379\
The Commission further proposed deleting the accountant independence
language in paragraph (e)(1)(i) of Rule 17a-5.\380\ In addition, the
Commission proposed deleting paragraph (f)(3) and re-designating
paragraph (f)(4) as paragraph (f)(3).\381\ These proposed amendments to
paragraph (f) of Rule 17a-5 would consolidate the provisions of
paragraphs (e)(1)(i), (f)(1), and (f)(3) of Rule 17a-5 into paragraph
(f)(1) and make Rule 17a-5 consistent with other Commission
requirements governing the qualifications of accountants. The
Commission received no comments on these proposals and is adopting them
substantially as proposed.\382\
---------------------------------------------------------------------------

    \379\ See Broker-Dealer Reports, 76 FR at 37593-37594.
    \380\ Id.
    \381\ Id.
    \382\ See paragraph (f)(1) of Rule 17a-5. The Commission has
revised paragraph (f)(1) of Rule 17a-5 from the proposal to: Change
the title from ``Qualification of accountants'' to ``Qualifications
of independent public accountant;'' and deleting the words ``in
addition.''
---------------------------------------------------------------------------

    Although the underlying independence requirements have not changed,
broker-dealers and their independent public accountants are reminded
that they must comply with the independence requirements of Rule 2-01
of Regulation S-X.\383\ As a result of the Sarbanes-Oxley Act of 2002,
Rule 2-01 of Regulation S-X was strengthened, including increased
restrictions on the provision of certain non-audit services to an audit
client.\384\
---------------------------------------------------------------------------

    \383\ See 17 CFR 210.2-01.
    \384\ See Strengthening the Commission's Requirements Regarding
Auditor Independence, Exchange Act Release No. 47265 (Jan. 28,
2003), 68 FR 6006 (Feb. 5, 2003). See also Auditor Independence: SEC
Review of Auditor Independence Rules, NASD Notice to Members 02-19
(Mar. 2002).
---------------------------------------------------------------------------

    Under the Commission's rules, an accountant will not be recognized
as independent with respect to an audit client if the accountant is
not, or a reasonable investor with knowledge of all relevant facts and
circumstances would conclude that the accountant is not, capable of
exercising objective and impartial judgment on all issues encompassed
within the accountant's engagement. In determining whether an
accountant is independent, the Commission will consider all relevant
circumstances, including all relationships between the accountant and
the audit client, and not just those relating to reports filed with the
Commission.\385\ The standard is predicated largely on whether a
relationship or the provision of a service: (1) Creates a mutual or
conflicting interest between the accountant and the audit client; (2)
places the accountant in the position of auditing his or her own work;
(3) results in the accountant acting as management or an employee of
the audit client; or (4) places the accountant in a position of being
an advocate for the audit client.\386\
---------------------------------------------------------------------------

    \385\ See 17 CFR 210.2-01(b).
    \386\ See 17 CFR 210.2-01, Preliminary Note 2.
---------------------------------------------------------------------------

    Further, Rule 2-01 of Regulation S-X sets forth a non-exclusive
specification

of circumstances that are inconsistent with the general standard. For
example, the accountant is prohibited from providing the following non-
audit services, among others, to an audit client: \387\
---------------------------------------------------------------------------

    \387\ See 17 CFR 210.2-01(c).
---------------------------------------------------------------------------

     Bookkeeping or other services related to the accounting
records or financial statements of the audit client;
     Financial information systems design and implementation;
and
     Management functions or human resources.
    With respect to bookkeeping or other services related to the
accounting records or financial statements of the audit client, Rule 2-
01(c)(4)(i) of Regulation S-X specifies that these services include:
(1) Maintaining or preparing the audit client's accounting records; (2)
preparing financial statements that are filed with the Commission or
the information that forms the basis of financial statements filed with
the Commission; or (3) preparing or originating source data underlying
the audit client's financial statements.\388\
---------------------------------------------------------------------------

    \388\ See 17 CFR 210.2-01(c)(4)(i).
---------------------------------------------------------------------------

    Not all of the independence requirements in Rule 2-01 of Regulation
S-X that are applicable to audits of issuers are applicable to
engagements under Rule 17a-5. Specifically, auditors of broker-dealers
are not subject to the partner rotation requirements or the
compensation requirements of the Commission's independence rules
because the statute mandating those requirements is limited to
issuers.\389\ Additionally, auditors of broker-dealers are not subject
to the audit committee pre-approval requirements \390\ or the cooling-
off period requirements for employment \391\ because those requirements
only reference issuers.
---------------------------------------------------------------------------

    \389\ See 15 U.S.C. 78j-1.
    \390\ See 17 CFR 210.2-01(c)(7).
    \391\ See 17 CFR 210.2-01(c)(2).
---------------------------------------------------------------------------

F. Notification of Non-Compliance or Material Weakness

    As discussed in detail below, the Commission is amending the
notification provisions in Rule 17a-5 and amending Rule 17a-11 to align
that rule with the amendments to Rule 17a-5. Under Rule 17a-11, a
broker-dealer must provide notice to the Commission and its DEA in
certain circumstances.\392\ For example, paragraph (b)(1) of Rule 17a-
11 requires a broker-dealer to give notice if its net capital declines
below the minimum amount required under Rule 15c3-1.\393\ Rule 15c3-1
and Rule 15c3-3 also require broker-dealers to provide notification in
certain circumstances.\394\ For example, paragraph (i) of Rule 15c3-3
requires a carrying broker-dealer to immediately notify the Commission
and its DEA if it fails to make a deposit into its customer reserve
account as required by paragraph (e) of Rule 15c3-3.\395\
---------------------------------------------------------------------------

    \392\ See 17 CFR 240.17a-11.
    \393\ See 17 CFR 240.17a-11(b)(1).
    \394\ See, e.g., 17 CFR 240.15c3-1(a)(6)(iv)(B); 17 CFR
240.15c3-1(a)(6)(v); 17 CFR 240.15c3-1(a)(7)(ii); 17 CFR 240.15c3-
1(c)(2)(x)(C)(1); 17 CFR 240.15c3-1(e); 17 CFR 240.15c3-1d(c)(2); 17
CFR 240.15c3-3(i).
    \395\ See 17 CFR 240.15c3-3(i).
---------------------------------------------------------------------------

1. New Notification Requirements--Paragraph (h) of Rule 17a-5
    Prior to today's amendments, paragraph (h)(2) of Rule 17a-5
provided that if, during the course of the audit or interim work, the
independent public accountant determined that any ``material
inadequacies'' existed, then the independent public accountant was
required to inform the chief financial officer (``CFO'') of the broker-
dealer, who, in turn, was required to give notice to the Commission and
the broker-dealer's DEA within 24 hours in accordance with the
provisions of Rule 17a-11.\396\ The rule also provided that the broker-
dealer must furnish the independent public accountant with the notice,
and if the independent public accountant failed to receive the notice
within the 24 hour period, or if the accountant disagreed with any
statements contained in the notice, the independent public accountant
was required to inform the Commission and the DEA within the next 24
hours.\397\ In that event, the independent public accountant was
required to describe any material inadequacies found to exist or, if
the broker or dealer filed a notice, the independent public accountant
was required to detail the aspects of the broker-dealer's notice with
which the independent public accountant did not agree.\398\
---------------------------------------------------------------------------

    \396\ See 17 CFR 240.17a-5(h)(2).
    \397\ Id.
    \398\ Id.
---------------------------------------------------------------------------

i. The Proposed Amendments
    The proposed amendments to Rule 17a-5 would have replaced
references to material inadequacies, including the material inadequacy
report, with a requirement applicable to carrying broker-dealers to
identify an instance of ``material non-compliance'' with the financial
responsibility rules and any material weakness in internal control over
compliance with the financial responsibility rules in the compliance
report and the requirement to engage an independent public accountant
to examine the compliance report.\399\ Consistent with those proposed
changes, the Commission proposed amending the notification provisions
of paragraph (h)(2) of Rule 17a-5 to replace the term ``material
inadequacy'' with the term ``material non-compliance,'' which would
result in a requirement to notify the Commission upon the discovery by
the accountant during the course of preparing a report based on an
examination of the compliance report of an instance of material non-
compliance as that term was proposed to be defined under the
amendments.\400\
---------------------------------------------------------------------------

    \399\ See Broker-Dealer Reports, 76 FR at 37575-37579.
    \400\ Id. at 37579.
---------------------------------------------------------------------------

    The Commission also proposed amending provisions regarding the
notification process.\401\ Under the proposal, the accountant would
have been required to notify the Commission and the broker-dealer's DEA
directly.\402\ In the proposing release, the Commission stated that it
preliminarily believed these changes would provide more effective and
timely notice of broker-dealer compliance deficiencies and enable the
Commission to react more quickly to protect customers and others
adversely affected by those deficiencies.\403\ The amendments also
would have been consistent with the notification requirement in Rule
206(4)-2 that is triggered in the context of a ``surprise'' examination
of an investment adviser.\404\
---------------------------------------------------------------------------

    \401\ Id.
    \402\ Id.
    \403\ Id.
    \404\ Id. Rule 206(4)-2 provides, in pertinent part, that upon
finding any ``material discrepancies'' during the ``surprise''
examination of an investment adviser to verify client funds and
securities, the independent public accountant must notify the
Commission within one business day. 17 CFR 275.206(4)-2(a)(4)(ii).
---------------------------------------------------------------------------

ii. Comments Received
    The Commission received numerous comments in response to this
proposal.\405\ Most of these commenters objected to the proposed
notification process.\406\ Among the reasons given were that it would
be inappropriate to require the accountant to notify the Commission and
the DEA directly, because, among other things, the broker-dealer is
principally responsible for compliance with the securities laws,

including timely notification; \407\ that PCAOB standards provide that
``the practitioner should not take on the role of the responsible
party;'' \408\ and that PCAOB attestation standards (which were
referenced in the proposing release) clearly provide that management is
responsible for the subject matter to which it is asserting, and not
the accountant.\409\ In addition, one commenter stated that alignment
of notification procedures (that is, to require the accountant to
notify the Commission directly) between Rule 17a-5 and Rule 206(4)-2 is
not necessary, given the other auditing and reporting responsibilities
in place or proposed.\410\ In addition to suggestions that the
notification process that existed prior to today's amendments should
not be changed,\411\ one commenter stated that the rule should require
simultaneous notice by the accountant to the Commission and to the
firm's management.\412\
---------------------------------------------------------------------------

    \405\ 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.
    \406\ See ABA Letter; CAI Letter; CAQ Letter; Deloitte Letter;
E&Y Letter; Grant Thornton Letter; KPMG Letter; McGladrey Letter;
PWC Letter; Van Kampen/Invesco Letter.
    \407\ See Deloitte Letter.
    \408\ See KPMG Letter. See also PCAOB Interim Attestation
Standard, AT Section 101 at ] .13.
    \409\ See PWC Letter. See also PCAOB Interim Attestation
Standard, AT Section 101 at ]] .11-.13.
    \410\ See E&Y Letter.
    \411\ See, e.g., ABA Letter; E&Y Letter; McGladrey Letter.
    \412\ See Van Kampen/Invesco Letter.
---------------------------------------------------------------------------

    In addition, one commenter asked whether the notification
provisions apply to a review of the exemption report.\413\ Another
commenter stated that a report of non-compliance also will trigger a
Rule 17a-11 notice, which would be duplicative and create
confusion.\414\
---------------------------------------------------------------------------

    \413\ See KPMG Letter.
    \414\ See ABA Letter.
---------------------------------------------------------------------------

iii. The Final Rule
    In part in response to comments received, and to achieve
consistency with other revisions to the proposed rule amendments
described above, the notification provisions in the final rule have
been modified from the proposed amendments.\415\ First, the Commission
is persuaded by comments received that the primary obligation to notify
the Commission should remain with the broker-dealer.\416\ Therefore,
the notification process in place before today's amendments generally
has been retained.
---------------------------------------------------------------------------

    \415\ See paragraph (h) of Rule 17a-5.
    \416\ As the proposal noted, the proposed amendment to require
the independent public accountant to notify the Commission directly
of material non-compliance would have been consistent with the
surprise examination notification requirement in Rule 206(4)-2 under
the Advisers Act. A surprise examination of an investment adviser by
an independent public accountant generally verifies that client
funds and securities of which the investment adviser has custody are
held by a qualified custodian, such as a bank or broker-dealer. The
accountant's surprise examination report opines on the adviser's
compliance with the custody rule requirement that client funds and
securities are maintained by a qualified custodian and also opines
on the adviser's compliance with certain recordkeeping obligations
between surprise examinations. The difference in nature and scope of
custodial and other activities between broker-dealers and advisers
results in significantly broader examination requirements for
broker-dealers. Broker-dealers are required to undergo an annual
examination by an independent public accountant of their financial
statements and certain supporting schedules: 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. Moreover, under
today's amendments, the independent public accountant must examine
the compliance report of broker-dealers that maintain custody of
customer funds or securities. The differences in the overall nature
of an examination also supports continuing to maintain today's model
under which a broker-dealer has the primary notification obligation
(e.g., unlike in the case of a surprise examination of an investment
adviser, a broker-dealer would already be making its own assessment
and preparing its own report in the case of a compliance report
examination). Further, the Dodd-Frank Act provided the PCAOB with
explicit authority to, among other things, establish (subject to
Commission approval) auditing and related attestation, quality
control, ethics, and independence standards for registered public
accounting firms with respect to their preparation of audit reports
to be included in broker-dealer filings with the Commission, and the
authority to conduct and require an inspection program of registered
public accounting firms that audit broker-dealers. The PCAOB
oversight of broker-dealer examinations provides additional
regulatory oversight with respect to the examination of the broker-
dealer further supporting the retention of the primary obligation