substantially as proposed.
---------------------------------------------------------------------------

    \74\ See AT sec. 101.21.
---------------------------------------------------------------------------

    With respect to documentation, the attestation engagements are
subject to the requirements of Auditing Standard No. 3, Audit
Documentation, which applies to engagements conducted pursuant to the
standards of the PCAOB. Auditing Standard No. 3 states that as audit
documentation is the written record that provides the support for the
representations in the auditor's report, it should demonstrate that the
engagement complied with the standards of the PCAOB.\75\ Further, as
there are potentially a variety of ways for the auditor to document
their understanding of the financial responsibility rules and other
rules and regulations, the examination standard does not prescribe any
specific manner to do so. A note has been added to paragraph 6 of the
examination standard to remind auditors of their responsibility to
comply with Auditing Standard No. 3.
---------------------------------------------------------------------------

    \75\ See paragraph 4 of Auditing Standard No. 3.
---------------------------------------------------------------------------

    The proposed examination standard included a footnote which stated
that ``due professional care'' referred to in that paragraph was the
same term in paragraph .40 of AT sec. 101. One commenter stated that
while the commenter did not disagree with the meaning of ``due
professional care,'' referencing AT sec. 101 from the examination
standard may be confusing, especially as AT sec. 101 would not be
applicable to engagements in which the examination standard is
applicable. In the examination standard, a note has been added to state
that due professional care imposes a responsibility on each engagement
team member to comply with the examination standard and that the
exercise of due professional care requires critical review at every
level of supervision of the work done and the judgment exercised by
those assisting in the engagement, including the preparation of the
report. A footnote to that note states that the auditor's
responsibility to exercise due professional care is consistent with the
description in paragraphs .40-.41 of AT sec. 101.
    The Board did not receive other significant comments on the general
requirements of the proposed examination standard. As such, the general
requirements are being adopted substantially as proposed.
Relationship Between the Examination Engagement and the Audit of the
Financial Statements and Audit Procedures Performed on Supplemental
Information (Paragraph 8 of Attestation Standard No. 1)
    By its terms, SEC Rule 17a-5 requires the financial statement audit
and the compliance examination to be performed by the same auditor.\76\
Accordingly, the examination standard includes a requirement for the
auditor to coordinate the examination engagement with the audit of the
financial statements and the audit procedures performed on supplemental
information. The emphasis on appropriately coordinating the examination
engagement with the audit of the financial statements and the audit
procedures performed on supplemental information should promote overall
audit effectiveness and avoid redundancy in the auditor's work.
---------------------------------------------------------------------------

    \76\ See paragraph (g) of SEC Rule 17a-5.
---------------------------------------------------------------------------

    For example, the examination standard includes a requirement for
the auditor to take into account evidence from the audit of the
financial

statements in planning and performing procedures for the examination
engagement and in evaluating the results of the procedures performed in
the examination. This enables the auditor to plan, perform, and
evaluate the results of the examination engagement concurrent with the
audit of the financial statements because the examination standard is
structured similarly to, and contains many of the same concepts
included in, auditing standards related to the auditor's assessment of
and response to risk.\77\
---------------------------------------------------------------------------

    \77\ See generally, Auditing Standards Nos. 8-15.
---------------------------------------------------------------------------

    The proposing release requested comments on other ways the Board
could promote coordination of the examination engagement with the audit
of the financial statements and the audit procedures performed on
supplemental information. Commenters generally stated that requirements
regarding the coordination of the examination engagement with the audit
of the financial statements were appropriate.
    One commenter stated that the Board should require the auditor of
the financial statements to perform the examination engagement and
issue the examination report. As noted previously, SEC Rule 17a-5
includes this requirement.\78\ Thus, the attestation standards do not
include specific requirements for performing the examination or review
if the auditor did not audit the financial statements.
---------------------------------------------------------------------------

    \78\ See paragraph (g) of SEC Rule 17a-5.
---------------------------------------------------------------------------

    Another commenter stated that it is inappropriate to require that
the auditor plan and perform the work to meet the objectives of both
the examination engagement and the financial statement audit, and that
the auditor's obligation under the examination standard is to meet the
objectives of the examination engagement. The language in the standard
was retained as proposed. The auditor should plan and perform the work
to meet the objectives of both the examination engagement as well as
the financial statement audit. Existing auditing standards require the
auditor to properly plan and perform the financial statement audit.\79\
Since the objectives are not identical, the auditor must plan and
perform the work to achieve the objectives of both engagements.
Further, the examination standard does require the auditor to take into
account the evidence obtained and the results of procedures performed
during the audit of the financial statements and the audit procedures
performed on the supplemental information in planning and performing
procedures for the examination engagement and in evaluating the results
of the procedures performed in the examination engagement.
---------------------------------------------------------------------------

    \79\ See Auditing Standard No. 9, Audit Planning.
---------------------------------------------------------------------------

Consideration of Fraud (Paragraph 10 of Attestation Standard No. 1)
    The auditor's consideration of fraud is an important part of the
examination engagement. Fraud risks particularly relevant to a broker's
or dealer's non-compliance with the financial responsibility rules
include the risk of misappropriation of customer funds or securities
held for customers and intentional manipulation of the books and
records to conceal material misappropriations or other non-compliance.
The SEC Release notes that the amendments to SEC Rule 17a-5, which
include requiring the examination and review engagements, are designed
to provide additional safeguards with respect to broker and dealer
custody of customer securities and funds.\80\
---------------------------------------------------------------------------

    \80\ See the SEC Release at 206.
---------------------------------------------------------------------------

    Paragraph 10 of the examination standard includes a requirement for
the auditor to assess the risk of fraud, and specifically refers to the
risk of misappropriation of customer assets, which is relevant to
compliance with the net capital rule and the reserve requirements rule,
as well as the broker's or dealer's Internal Control Over Compliance.
    The requirement to coordinate the examination engagement with the
audit of the financial statements and audit procedures performed on
supplemental information is also important for the proper assessment of
fraud risk in the examination engagement. The auditor's assessment of
fraud risk in the examination engagement will be informed to a
substantial degree by the procedures performed and the fraud risk
assessments in the audit of the financial statements and audit
procedures performed on supplemental information. Many of the fraud
risk factors identified in the financial statement audit regarding (1)
incentives or pressures to misappropriate assets or commit fraudulent
financial reporting, and (2) attitudes and rationalizations that
justify such fraudulent actions,\81\ are relevant when identifying and
assessing risks of misappropriation of customer assets or intentional
manipulation of the books and records to conceal misappropriation of
customer assets or non-compliance with the financial responsibility
rules. Also, weaknesses in controls regarding safeguarding of assets or
stock records can result in opportunities for misappropriation of
customer assets or non-compliance. In addition, the evaluation of
misstatements for indications of fraud or matters identified during the
audit that might affect the assessment of fraud risks in the audit of
the financial statements also might affect the assessment of fraud
risks in the examination engagement.\82\
---------------------------------------------------------------------------

    \81\ See paragraphs 65-66 of Auditing Standard No. 12,
Identifying and Assessing Risks of Material Misstatement, and
paragraph 85 of AU sec. 316, Consideration of Fraud in a Financial
Statement Audit.
    \82\ See paragraphs 19-22, 28-29 and Appendix C of Auditing
Standard No. 14, Evaluating Audit Results.
---------------------------------------------------------------------------

    Paragraph 9.d. of the examination standard includes a requirement
for the auditor to assess the risks associated with related parties,
including related parties that are investment advisors or entities with
which the broker or dealer has a custodial or clearing relationship,
that are relevant to compliance and controls over compliance. Given the
nature of the transactions with related parties that are investment
advisors or entities with which the broker or dealer has a custodial or
clearing relationship, they are particularly relevant to the auditor's
consideration of the risks associated with related parties in the
examination engagement and in considering both the broker's or dealer's
assertions related to Internal Control Over Compliance, as well as to
the broker's or dealer's assertion related to compliance with the net
capital rule and the reserve requirements rule.
    Likewise, paragraph 9.j. of the examination standard includes a
requirement for the auditor to obtain an understanding of the nature
and frequency of customer complaints that are relevant to compliance
with the financial responsibility rules, which can provide evidence
relevant to the assessment of fraud risks, especially if there is a
high incidence of customer complaints, thematic issues in the
complaints that indicate the potential for misappropriation of customer
assets, or specific allegations of fraud or misfeasance by the broker's
or dealer's customers.
    Other paragraphs in the examination standard address the auditor's
responsibilities for responding to fraud risks. For example, paragraph
22 of the examination standard retains an important requirement from
the proposed examination standard for the auditor to perform compliance
tests that are responsive to risks, including fraud risks. Also,
paragraph 23 of the examination standard retains from the proposal the
requirement for the auditor to perform procedures to obtain evidence
about the existence of

customer funds or securities held for customers. This is an important
responsibility in an audit of a broker or dealer that has access to
customer assets. It affects compliance with the net capital rule and
the reserve requirements rule, and it has the potential to result in
contingent liability to the broker or dealer that requires recognition
or disclosure in the financial statements.
    Because the examination standard requires the auditor to perform
tests that are responsive to fraud risks, the nature, timing, and
extent of procedures to obtain evidence about the existence of assets
held for customers should be commensurate with the risk of
misappropriation of customer assets. Determining the necessary
procedures involves considering relevant risk factors, including, but
not limited to, the amount of cash and securities held for customers
and the results of testing and evaluation of the relevant controls.
Examples of procedures that provide evidence about the existence of
customer assets include (1) counting customer securities or observing
and testing the broker's or dealer's procedures for physical inspection
and (2) confirming customer security positions directly with
depositories and clearing organizations. Procedures performed in the
audit of the financial statements and the audit procedures performed on
supplemental information to test the existence of assets held for
customers also provide relevant evidence in the examination engagement.
    The Board requested comment regarding whether specific requirements
should be added to either of the proposed attestation standards to
further enhance protection of customer assets. One commenter stated
that generally the attestation standards are adequate to enhance
protection of customer assets. Another commenter stated that the
principles in the examination standard for performing compliance tests
are sufficiently clear.
    One commenter recommended that the Board clarify the extent and
timing of procedures included as examples in paragraph 26 of the
proposed examination standard regarding procedures that provide
evidence about the existence of customer assets. The examination
standard requires the auditor to perform procedures to obtain evidence
of customer funds or securities held for customers, but the standard
does not prescribe specific procedures for the auditor to perform to
obtain such evidence. The procedures included in the note to paragraph
23 of the examination standard are examples of procedures that the
auditor might perform to obtain such evidence. The necessary extent and
timing of those procedures depends on, among other things, the
complexity of the operations of the broker's or dealer's business, the
nature of carrying and clearing arrangements, and the design and
effectiveness of controls related to the existence assertion. As such,
the examination standard has not been changed to reflect this comment.
Testing Controls Over Compliance (Paragraphs 11-20 of Attestation
Standard No. 1)
    SEC Rule 17a-5 requires the broker's or dealer's compliance report
to include an assertion regarding the effectiveness of Internal Control
Over Compliance during the most recent fiscal year and as of the end of
the fiscal year.\83\ Accordingly, the examination standard requires the
auditor to obtain evidence about the design and operating effectiveness
of relevant controls over compliance throughout the fiscal year and as
of the end of the fiscal year.
---------------------------------------------------------------------------

    \83\ See paragraphs (d)(3)(i)(A)(2) and (3) of SEC Rule 17a-5,
which requires the broker or dealer to assert on the effectiveness
of its Internal Control Over Compliance with the financial
responsibility rules throughout the fiscal year and as of the end of
the most recent fiscal year.
---------------------------------------------------------------------------

    The examination standard requires the auditor to test those
controls that are important to the auditor's conclusion about whether
the broker or dealer maintained effective Internal Control Over
Compliance for each financial responsibility rule during the fiscal
year and as of the end of the fiscal year. The examination standard
also requires the auditor to obtain evidence that the controls over
compliance selected for testing are designed effectively and operated
effectively during the fiscal year and as of the fiscal year end.\84\
---------------------------------------------------------------------------

    \84\ See paragraphs (d)(3)(i)(A)(2) and (3) of SEC Rule 17a-5,
which requires the broker or dealer to assert on the effectiveness
of its Internal Control Over Compliance throughout the fiscal year
and as of the broker's or dealer's fiscal year end. See also
paragraphs (d)(3)(i)(B) and (C) of SEC Rule 17a-5, which require the
broker or dealer to describe each material weakness in Internal
Control Over Compliance and any instance of non-compliance with the
net capital rule or reserve requirements rule.
---------------------------------------------------------------------------

    As the broker's or dealer's assertion regarding Internal Control
Over Compliance relates to each financial responsibility rule
individually, the auditor should obtain evidence about the
effectiveness of the selected controls for each financial
responsibility rule. However, when testing controls over compliance,
the auditor's objective is not to support an opinion about the
effectiveness of each individual control, rather, the objective is to
form an opinion about whether the broker's or dealer's assertions
regarding Internal Control Over Compliance are fairly stated, in all
material respects. This allows the auditor to focus his or her effort
on the controls that are important to each of the financial
responsibility rules and to vary the level of evidence obtained
regarding the effectiveness of individual controls selected for testing
based on the risk associated with the individual control.
    One commenter recommended that the examination standard include
guidance regarding the identification of controls important to the
auditor's conclusion about whether the broker or dealer maintained
effective internal controls over compliance for each financial
responsibility rule. As the financial responsibility rules outline the
requirements necessary to be in compliance, the auditor can identify
the controls for testing by understanding the controls the broker or
dealer has implemented to assure compliance with the respective
requirements.
    Additionally, the examination standard identifies certain factors
that affect the risk associated with a control. One factor included in
paragraph 13 is the broker's or dealer's history of instances of non-
compliance with the financial responsibilities rules that the control
is intended to prevent or detect. A recent history of non-compliance
generally indicates higher risk associated with the control. Factors
that affect the risk associated with a control include, but are not
limited to, those described in paragraph 13 of the examination
standard.
    Another factor included in paragraph 13 includes the extent of use
of part-time personnel. Some commenters stated that they did not agree
that the use of part-time personnel is a factor that affects the risk
associated with a control. Those commenters stated that this risk
factor is incorporated in another risk factor regarding the competence
of the personnel who perform the control or monitor its performance.
One commenter stated that, in their opinion, it would be more
appropriate to evaluate the competence and objectivity of personnel
executing the controls and their knowledge of the financial
responsibility rules.
    In considering these comments, the Board took into account the
SEC's June 2007 compliance alert,\85\ which noted that SEC examinations
found that many part-time financial and operational principals did not
actually supervise or

create and maintain various books and records. In light of risks
illustrated in the SEC compliance alert, the use of part-time personnel
has been retained in the examination standard as a risk factor for the
auditor to consider when testing internal controls over compliance. The
auditor's understanding of the role and responsibilities of the part-
time personnel is important to evaluating the associated risks.
---------------------------------------------------------------------------

    \85\ See Compliance Alert, June 2007, available at http://www.sec.gov/about/offices/ocie/complialert.htm.
---------------------------------------------------------------------------

    Paragraphs 14-18 of the examination standard provide requirements
for the auditor to test the design and operating effectiveness of the
selected controls over compliance. These requirements for testing
design and operating effectiveness of controls over compliance are
analogous to the requirements for testing controls in Auditing Standard
No. 13, The Auditor's Responses to the Risks of Material Misstatement.
    Under the examination standard, the auditor should obtain evidence
about the effectiveness of controls each year. Similar to testing
controls in a financial statement audit, the examination standard
provides factors for the auditor to take into account if the auditor
plans to use evidence obtained in prior years in determining the extent
of testing in the current year.
    One commenter recommended that paragraph 16 of the proposed
examination standard, which stated ``[a]s the risk associated with the
control being tested increases, the evidence that the auditor should
obtain also increases,'' be replaced with paragraph 18 of Auditing
Standard No. 13, which states that [t]he auditor should obtain more
persuasive audit evidence. . . .'' The suggested revision is consistent
with the intent of the requirement, so it has been included in
paragraph 12 of the examination standard. This change will focus the
auditor on the persuasiveness of audit evidence, rather than quantity,
and avoid unnecessary differences between the examination standard and
the auditing standards. Similar changes are reflected in paragraphs 22
and 24 of the examination standard.
    Paragraphs 19 and 20 of the examination standard describe the
auditor's use of evidence obtained in past examination engagements and
using tests of controls that are modified during the year. One
commenter suggested that as changes to controls occur throughout the
period, the examination standard should require the auditor to
determine with management what types of changes could materially affect
control effectiveness. That commenter stated that the auditor should
then test and evaluate management's documentation of the changes to
controls and perform procedures to test the broker's or dealer's
implementation of that change. SEC Rule 17a-5 requires that the broker
or dealer assert that its controls were effective during the most
recent fiscal year. As stated in the examination standard, to evaluate
controls over compliance throughout the period, the auditor should
obtain evidence regarding the design effectiveness of the selected
controls before and after the change. Further, the examination standard
also requires that, if a broker or dealer makes changes to its policies
and procedures or key personnel during the fiscal year, the auditor
should obtain an understanding of the reason for the change and obtain
evidence regarding the design and operating effectiveness of the
superseded and new controls before and after the change.
    One commenter stated that the phrase within paragraph 20 of the
proposed examination standard which stated, ``whether each control is
operating as designed'' might be confusing and recommended revising the
paragraph to state ``each control selected for testing.'' The suggested
revision is consistent with the intent of the requirement, so it has
been included in paragraph 16 of the examination standard.
Performing Compliance Tests (Paragraphs 21-24 of Attestation Standard
No. 1)
    Paragraphs 21-24 set forth requirements for performing tests of
compliance with the net capital rule and reserve requirements rule.
    With respect to compliance tests, the auditor's objective is to
form a conclusion about whether the broker's or dealer's assertion
regarding compliance with the net capital rule and the reserve
requirements rule is fairly stated, in all material respects. To
satisfy this objective, the examination standard requires the auditor
to perform procedures that are sufficient to support the auditor's
conclusions regarding whether the broker or dealer was in compliance
with the net capital rule and reserve requirements rule as of the end
of its most recent fiscal year.
    The examination standard requires the auditor to perform specific
procedures on the schedules the broker or dealer used to determine
compliance with the net capital rule and the reserve requirements rule
as of the end of its fiscal year, including:
    a. Evaluating whether the amounts in the schedule were determined
in accordance with the net capital rule or reserve requirements rule,
as applicable;
    b. Testing the accuracy and completeness of the information in the
schedule;
    c. Determining whether the broker or dealer maintained the required
level of net capital in accordance with the net capital rule;
    d. Determining whether the broker or dealer maintained a special
reserve bank account for the exclusive benefit of customers and
deposited funds in at least the required amount in accordance with the
reserve requirements rule;
    e. Determining whether the information in the schedule was derived
from the books and records of the broker or dealer; and
    f. Determining whether the broker or dealer made the notifications,
if any, required by the net capital rule and reserve requirements rule
as of the end of the most recent fiscal year.
    Paragraph 21.e. of the examination standard requires the auditor to
perform procedures to determine whether the information used to assert
compliance with the net capital rule and the reserve requirements rule
was derived from the broker's or dealer's books and records. Proper
coordination of these procedures with the audit of the financial
statements and audit procedures performed on supplemental information
should allow the auditor to avoid redundancy in the auditor's work and
increase the effectiveness of the procedures performed. For example,
Auditing Standard No. 17, Auditing Supplemental Information
Accompanying Audited Financial Statements, includes a requirement for
the auditor to determine that the supplemental information reconciles
to the underlying accounting and other records or to the financial
statements themselves, as applicable. Such supplemental information
includes the supporting schedules that brokers or dealers are required
to include in their financial reports pursuant to SEC Rule 17a-5.\86\
---------------------------------------------------------------------------

    \86\ See paragraph (d)(2) of SEC Rule 17a-5.
---------------------------------------------------------------------------

    To test compliance pursuant to paragraph 21, the auditor will need
to design his or her procedures to test the provisions of the net
capital rule and reserve requirements rule that have a bearing on the
broker's or dealer's compliance with that rule. For example, the
current requirements in the net capital rule generally include:
    a. The requirement to maintain minimum net capital and tentative
net capital, as applicable, at all times.\87\
---------------------------------------------------------------------------

    \87\ See paragraph (a) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    b. The requirement for certain brokers or dealers not to let a
specified amount of certain accounts it carries exceed a

specified threshold for more than five business days.\88\
---------------------------------------------------------------------------

    \88\ See paragraph (a)(6)(v) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    c. The requirement for brokers or dealers carrying accounts of
listed options specialists not to let the amount of certain deductions
required under Appendix A of the net capital rule to exceed a specified
threshold for more than three business days.\89\
---------------------------------------------------------------------------

    \89\ See paragraph (c)(2)(x)(C) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    d. The notification requirement relating to paragraph (c)(2)(x)(C)
of the net capital rule.\90\
---------------------------------------------------------------------------

    \90\ See paragraph (c)(2)(x)(C)(1) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    e. The requirement for brokers or dealers carrying accounts of
listed options specialists to liquidate accounts when a liquidating
deficit exists which includes a notice requirement.\91\
---------------------------------------------------------------------------

    \91\ See paragraph (c)(2)(x)(D) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    f. The requirement that the total of outstanding principal amounts
of satisfactory subordination agreements cannot exceed 70% of the
broker's or dealer's debt-equity total for a period in excess of 90
days.\92\
---------------------------------------------------------------------------

    \92\ See paragraph (d) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    g. The notification requirements relating to withdrawals of equity
capital.\93\
---------------------------------------------------------------------------

    \93\ See paragraph (e)(1) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    h. The limitations on withdrawal of equity capital.\94\
---------------------------------------------------------------------------

    \94\ See paragraph (e)(2) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    i. The requirements regarding temporary restrictions on net capital
withdrawals.\95\
---------------------------------------------------------------------------

    \95\ See paragraph (e)(3) of 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    Other provisions of the rule also may apply depending on the
particular activities or elections of the broker or dealer. Auditors
should look to the requirements of the individual rules in order to
test compliance.\96\
---------------------------------------------------------------------------

    \96\ See paragraph 6.b. of the examination standard, which
requires the auditor to obtain an understanding of the financial
responsibility rules and other rules and regulations that are
relevant to the broker's or dealer's assertions.
---------------------------------------------------------------------------

    The requirements for testing compliance with the net capital rule
and the reserve requirements rule should facilitate the coordination of
the examination engagement and the audit procedures performed on
supplemental information. The compliance procedures, if properly
planned and performed, should provide substantial evidence to satisfy
the requirements of Auditing Standard No. 17.
    As discussed earlier, in view of the amendments to SEC Rule 17a-5
adopted by the Commission, the examination standard was revised to more
closely align the auditor's performance requirements with the scope of
the compliance assertion in SEC Rule 17a-5. It is appropriate to
include specific procedures the auditor should perform on the schedules
the broker or dealer used to determine compliance with the net capital
rule and the reserve requirements rule as of the end of its fiscal
year.
    In addition to those procedures that the auditor would perform on
the broker's or dealer's schedules when planning and performing
compliance tests, the auditor should take into account the evidence
obtained from procedures performed as part of the audit of the
financial statements and the audit procedures performed on supplemental
information. For example, certain audit procedures performed to test
the valuation and classification of the broker's or dealer's
investments as of the end of the fiscal year may provide relevant
evidence regarding the broker's or dealer's compliance with the net
capital rule. Further, when testing the broker's or dealer's cash and
cash equivalents, certain audit procedures may provide evidence
regarding the existence of special reserve bank accounts for the
exclusive benefit of customers, as well as evidence about the deposits
to, and withdrawals from, those bank accounts. Such evidence may be
relevant to the broker's or dealer's compliance with the reserve
requirements rule. However, as the objectives of the audit and the
examination engagement are not the same, the auditor must plan and
perform the work to meet the objectives of both engagements.
Evaluating the Results of the Examination Procedures (Paragraphs 25-29
of Attestation Standard No. 1)
    Paragraph 25 of the examination standard states that in forming an
opinion on whether the assertions made by the broker or dealer in the
compliance report are fairly stated, in all material respects, the
auditor should evaluate all evidence obtained, regardless of whether
the evidence corroborates or contradicts the broker's or dealer's
assertions. Paragraph 26 of the examination standard provides that the
auditor should evaluate: (1) Identified instances of non-compliance
\97\ with the net capital rule and reserve requirements rule, to
determine whether any instances of non-compliance existed as of the end
of the most recent fiscal year; (2) identified instances in which the
information used to assert compliance with the net capital rule or the
reserve requirements rule was not derived from the broker's or dealer's
books and records to determine whether they are material, individually
or in combination; and (3) identified Deficiencies in Internal Control
Over Compliance to determine whether the deficiencies, individually or
in combination, are Material Weaknesses. Identified instances of non-
compliance might be an indication of a Deficiency in Internal Control
Over Compliance.
---------------------------------------------------------------------------

    \97\ In evaluating the results of compliance testing, an error
in a broker's or dealer's computation used to determine compliance
with a provision of the net capital rule or reserve requirements
rule is not an instance of non-compliance if, after giving
consideration to the effect of the error, the broker or dealer still
met the requirements of that provision, e.g., maintained at least
the required minimum level or net capital or at least the minimum
level on deposit in the special reserve account. However, such an
instance might be an indication of a Deficiency in Internal Control
Over Compliance that requires evaluation pursuant to this standard.
---------------------------------------------------------------------------

    The auditor's evaluation of the materiality of instances in which
the information used to assert compliance with the net capital rule or
the reserve requirements rule was not derived from the broker's or
dealer's books and records is based on relevant quantitative and
qualitative factors, including, in particular, the importance of the
information not derived from the books and records to the broker's or
dealer's compliance with the corresponding requirement in the net
capital rule or the reserve requirements rule. For example, when a
broker or dealer asserts that the information used to state whether it
was in compliance with the net capital rule was derived from its books
and records, and the auditor identifies an amount not derived from a
broker's or dealer's books and records, the broker or dealer may still
be able to support its assertion that it maintained the required net
capital using information that was derived from the books and records
of the broker or dealer. However, such an instance might be an
indication of a Deficiency in Internal Control Over Compliance.
    Paragraph 28 of the examination standard applies when the auditor
has not obtained sufficient appropriate evidence about an assertion or
has substantial doubt about an assertion. Pursuant to paragraph 28, the
auditor in those situations is required to perform additional
procedures to address the matter. Performing the examination with due
professional care requires an auditor conducting an examination to take
appropriate actions when becoming aware of non-compliance or Material
Weaknesses not included in the broker's or dealer's assertions or when
substantial doubt remains. This requirement is similar to the
requirement in paragraph 35 of Auditing

Standard No. 14, which states that if the auditor has not obtained
sufficient appropriate audit evidence about a relevant assertion or has
substantial doubt about a relevant assertion, the auditor should
perform procedures to obtain further audit evidence to address the
matter.
Obtaining a Representation Letter (Paragraphs 32-33 of Attestation
Standard No. 1)
    The examination standard includes a requirement for the auditor to
obtain written representations from management of the broker or dealer.
The failure to obtain written representations from management,
including management's refusal to furnish them, constitutes a
limitation on the scope of the examination engagement. See Reporting on
the Examination Engagement below for further discussion regarding scope
limitations.
    Overall, commenters were supportive of the requirement for the
auditor to obtain representations from management and stated that
obtaining representations from management is a necessary part of the
auditor's ability to support the auditor's opinion. One commenter
recommended that the auditor obtain a written representation from the
broker or dealer that acknowledges the broker's or dealer's
responsibility for the assertions in the compliance report. This
recommendation has been incorporated into paragraph 32.b. of the
examination standard.
    Commenters suggested additional representations that the auditor
should obtain from management during an examination engagement,
including representations regarding management's responsibility for
compliance with the financial responsibility rules, that management has
performed an evaluation of compliance, that management did not use the
auditor's procedures performed during the audit of the financial
statements or procedures performed on supplemental information as part
of the basis for management's assertions and that management has
disclosed to the auditor all known instances of non-compliance and
fraud. While many of these additional representations might be
appropriate based on the facts and circumstances of the examination
engagement, the examination standard was not modified to include them
as they are either duplicative of management's assertions or not
necessary to meet the requirements of the standard. However, the
examination standard does not preclude the auditor from obtaining
additional representations from management in situations in which the
auditor believes additional representations are appropriate.
Communication Requirements (Paragraphs 34-35 of Attestation Standard
No. 1)
    The examination standard requires the auditor to communicate
certain matters to management and the audit committee. These
requirements reflect changes from the proposed communication
requirements to conform to SEC Rule 17a-5. In addition, rather than
defining the term ``audit committee,'' the examination standard states
that the term ``audit committee'' has the same definition as that in
Auditing Standard No. 16, Communication with Audit Committees.
    One commenter stated that communication requirements in the
proposed examination standard are sufficient. Another commenter
requested that the Board clarify the meaning of ``identified'' as used
in paragraph 36 of the proposed examination standard. That commenter
questioned whether an ``identified'' instance of non-compliance
referred to the moment the auditor becomes aware of its existence or
only after the auditor concludes it represented a significant
deficiency. The language in the standard was retained as proposed. In
the context of the examination standard, the term ``identified instance
of non-compliance'' is meant to clarify that the communication
requirement applies to instances of non-compliance identified by the
auditor.\98\ A note has been included to paragraph 35 of the
examination standard reminding auditors of their obligation to comply
with the requirements of paragraph (h) of SEC Rule 17a-5.
---------------------------------------------------------------------------

    \98\ See also the discussion of the notification requirements in
the SEC Release at 101-107.
---------------------------------------------------------------------------

Reporting on the Examination Engagement (Paragraphs 36-38 of
Attestation Standard No. 1)
    The examination standard requires the auditor to issue a single
report that expresses an opinion on whether the assertions made by a
broker or dealer in a compliance report are fairly stated, in all
material respects, when expressing an unqualified opinion. Paragraph 36
of the standard includes basic report elements, while paragraph 37
includes an illustrative report.
    The reporting requirements in the examination standard have been
revised to align with the compliance report that is required by SEC
Rule 17a-5. This includes reporting on the broker's or dealer's
assertions regarding the effectiveness of Internal Control Over
Compliance during and as of the end of the most recent fiscal year,
compliance with the net capital rule and the reserve requirements rule,
and whether the information used to assert compliance with those rules
was derived from the broker's or dealer's books and records.
Legal Determinations, Discussion of Inherent Limitation of the
Examination, Discussion of Interpretations of Rules and Regulations,
and Restrictions on the Use of the Examination Report
    One commenter stated that the report clearly communicates the
auditor's responsibilities. Other commenters suggested that the
examination standard should address additional reporting matters, such
as including a caveat about legal determinations, discussion of
inherent limitations of the examination, discussion of interpretations
of rules and regulations, and restrictions on the use of the
examination report.
Legal Determinations
    Some commenters stated that the auditor's examination report should
be modified to include language indicating that the auditor's
examination does not provide for a legal determination of a broker's or
dealers compliance with financial responsibility rules. When the
auditor is engaged to perform an examination, it is necessary for the
auditor to read and make judgments regarding the application of the
regulatory requirements, as applicable to the engagement. The auditor's
report issued pursuant to the examination standard does not provide a
legal determination, nor does it purport to provide a legal
determination, of a broker's or dealer's compliance with the net
capital rule or the reserve requirements rule. However, such a report
may be useful to legal counsel or others in making such determinations.
In the context of an examination, the auditor expresses an opinion on
whether the assertions made by a broker or dealer in a compliance
report are fairly stated, in all material respects. Accordingly, the
Board did not add the suggested language to the examination standard.
Inherent Limitations of the Examination
    Some commenters stated that the examination report should be
revised to include language discussing the inherent limitations of the
examination, similar to language contained in other PCAOB auditing
standards. Those commenters recommended including a statement similar
to the statement

contained in the audit report on internal control over financial
reporting, which states that because of inherent limitations, internal
control over financial reporting may not prevent or detect
misstatements.\99\
---------------------------------------------------------------------------

    \99\ Paragraph 85.j. of Auditing Standard No. 5, An Audit of
Internal Control Over Financial Reporting That Is Integrated With an
Audit of Financial Statements.
---------------------------------------------------------------------------

    The examination standard does not prescribe reporting language
regarding the inherent limitations of the examination. Such language
might be confusing to users who interpret such a statement as a
limitation on the opinion expressed in the auditor's examination
report, rather than the nature of internal controls over compliance.
Also, an inherent limitation statement about internal control over
financial reporting, which is management's responsibility and the
subject of the audit, is different from a limitation statement about
the auditor's examination itself.
Interpretations of Rules and Regulations
    Several commenters stated that evaluating a broker's or dealer's
compliance with regulatory requirements may be based upon
interpretations of regulations or rules established by the Commission
and/or DEAs. Commenters recommended that the examination standard
permit the inclusion of a statement within the examination report
stating the description and the source of interpretations made by the
brokers and dealer's management. After considering these comments, a
footnote has been added to paragraph 36.h. of the examination standard.
The statement in the footnote is consistent with the existing
requirements of paragraph .59 of AT sec. 601, Compliance Attestation,
which allows the auditor to include a paragraph stating the description
and the source of interpretations made by the entity's management
immediately after the scope paragraph of the auditor's report. The
following is an example of such a paragraph:
    We have been informed that, under X Broker's interpretation of
[identify the compliance requirement, e.g. SEC Rule 15c3-1], [explain
the source and nature of the relevant interpretation].
    One commenter recommended that the auditor's examination report
should include a statement that the assertions are the responsibility
of the broker or dealer. The examination standard does not include this
language because the first sentence in the auditor's examination report
clarifies that the assertions are the responsibility of the broker or
dealer.
Restriction of Use of the Examination Report
    The proposed examination standard did not include provisions for
restricting the use of the examination report to specified parties.
Some commenters stated that audit firms previously have often
restricted the use of reports required by SEC Rule 17a-5 to the board
of directors, management, the Commission, and other regulatory agencies
that rely on SEC Rule 17a-5. Some commenters stated that a restriction
on the use of an auditor's examination or review report is appropriate,
given that general users of these reports may not have a sufficient
understanding of the subject matter to which they relate, such as the
financial responsibility rules.
    SEC Rule 17a-5 specifies the required reports, assertions, and the
compliance requirements related to these engagements. The reports
pursuant to this rule are generally filed only with the Commission, the
broker's or dealer's DEA, and the Securities Investor Protection
Corporation (``SIPC''). Accordingly, these criteria are suitable and
available for purposes of these engagements.
    As the reporting criteria have been established by the Commission
and those reporting criteria are publicly available, including language
restricting the auditor's examination report in the examination
standard is unnecessary. As such, no additional language is included in
the examination standard.
Examination Report Date (Paragraph 38 of Attestation Standard No. 1)
    Under paragraph 38 of the examination standard, the auditor should
date the examination report no earlier than the date on which the
auditor obtains sufficient appropriate evidence to support his or her
opinion. Because of the coordination between the examination
engagement, the audit of the financial statements and the audit
procedures performed on supplemental information, the date of the
examination report should not be earlier than the date of the auditor's
report on the financial statements and supplemental information. The
Board did not receive comments on the proposed dating of the report. As
such, these requirements are adopted as proposed.
Examination Report Modifications (Appendix C of Attestation Standard
No. 1)
    The examination standard includes an appendix (``Appendix C'') that
builds on existing concepts described in AT sec. 101 regarding report
modifications and adapts them as appropriate to the requirements of the
examination engagement.
    Under the examination standard, if one or more instances of non-
compliance with the net capital rule or the reserve requirements rule
exist as of the end of the most recent fiscal year, one or more
Material Weaknesses in Internal Control Over Compliance exist during or
as of the end of the most recent fiscal year, or the information used
to assert compliance with the net capital rule or the reserve
requirements rule was not derived, in all material respects, from the
books and records of the broker or dealer, the auditor must express an
adverse opinion directly on the subject matter of the respective
assertions, rather than on the assertions themselves, unless there is a
restriction on the scope of the examination engagement.\100\ For
example, if the broker or dealer is not in compliance with the net
capital rule, the auditor's report would include an adverse opinion on
compliance and would identify the instance of non-compliance regardless
of whether it was described in the broker's or dealer's compliance
report.
---------------------------------------------------------------------------

    \100\ The requirement to express an adverse opinion applies
regardless of whether the instance of non-compliance, material
weakness, or other matters preventing an unqualified opinion were
identified by management or the auditor.
---------------------------------------------------------------------------

    This requirement is different from AT sec. 101, which states that
``[r]eservations about the subject matter . . . can result in either a
qualified or an adverse opinion, depending on the materiality of the
departure from the criteria against which the subject matter . . . was
evaluated.'' \101\ Qualified opinions are not appropriate because any
instance of non-compliance as of the end of the fiscal year, any
Material Weakness in Internal Control Over Compliance during or as of
the end of the fiscal year, or any instance in which the information
used to assert compliance with the net capital rule and the reserve
requirements rule was not derived, in all material respects, from the
broker's or dealer's books and records, is by definition material and,
as such, must result in an adverse opinion.
---------------------------------------------------------------------------

    \101\ See AT sec. 101.76.
---------------------------------------------------------------------------

    The examination standard describes specific matters that the
auditor should include in the examination report when expressing an
adverse opinion. For example, when expressing an adverse opinion
because one or more Material Weaknesses exist, the auditor's
examination report must include a statement that one or more Material
Weaknesses have been identified and an identification of the
description of the

Material Weaknesses in the compliance report.
    The requirement to express an adverse opinion applies only to the
subject matter for the respective assertion. It does not require an
adverse opinion on the subject matter of all assertions in every
instance. For example, if a Material Weakness was identified during the
year but not at year end, and there were no instances of non-compliance
or instances in which the information used to assert compliance with
the net capital rule and the reserve requirements rule was not derived,
in all material respects, from the broker's or dealer's books and
records, the examination report should include an adverse opinion on
Internal Control Over Compliance during the year and an unqualified
opinion on the other three assertions.
    Several commenters recommended that the examination standard
include examples of modified examination reports. Appendix C to the
examination standard describes examination report modifications.
Additional report examples may be considered, if guidance is issued in
the future.
    Further, paragraph C6 of the examination standard states that, when
the auditor plans to disclaim an opinion and the limited procedures
performed by the auditor caused the auditor to make certain
conclusions, the auditor's report also must include the matters
described in paragraph C3 of the examination standard. Those
conclusions include that: (1) One or more instances of non-compliance
with the net capital rule or the reserve requirements rule existed as
of the end of the fiscal year, (2) one or more Material Weaknesses
existed during or as of the end of the most recent fiscal year, or (3)
the information used to assert compliance with the net capital rule or
the reserve requirements rule was not derived, in all material
respects, from the books and records of the broker or dealer.
    The examination standard states that the auditor may issue a report
disclaiming an opinion on the assertions made by a broker or dealer in
a compliance report as soon as the auditor concludes that a scope
limitation will prevent the auditor from obtaining the reasonable
assurance necessary to express an opinion. The auditor is not required
to perform any additional work before issuing a disclaimer when the
auditor concludes that he or she will not be able to obtain sufficient
evidence to express an opinion.
    In addition, unlike AT sec. 101, if the auditor concludes that he
or she cannot express an opinion because there has been a limitation on
the scope of the examination engagement, under the examination
standard, the auditor should communicate on a timely basis, in writing,
to management and the audit committee that the examination engagement
cannot be satisfactorily completed.
    Some commenters stated that when the auditor expresses an adverse
opinion, the auditor should report directly on the subject matter for
all assertions, rather than the respective assertion necessitating the
adverse opinion. As discussed, the examination standard aligns with the
requirements of SEC Rule 17a-5, which requires the auditor to report on
the respective management assertion.
    Under the examination standard, if the broker's or dealer's
compliance report contains other information in addition to the
statements and descriptions, if applicable, required by SEC Rule 17a-
5,\102\ the auditor should disclaim an opinion on the other
information. For example, if the broker's or dealer's compliance report
states that an identified Material Weakness no longer exists because
controls have been implemented after the end of the fiscal year that
address the Material Weakness, the auditor should disclaim an opinion
on this information.
---------------------------------------------------------------------------

    \102\ See paragraphs (d)(3) and (g)(2) of SEC Rule 17a-5.
---------------------------------------------------------------------------

    One commenter recommended that the examination standard address
instances when there is a misstatement of fact in management's
assertion, particularly when management's assertion is improperly
presented. SEC Rule 17a-5 establishes the assertions brokers and
dealers are required to make regarding compliance with the financial
responsibility rules. The auditor's responsibility is to express an
opinion on management's assertions. SEC Rule 17a-5 specifically
describes the content of the statements to be made by the broker or
dealer.\103\ Further, a misstatement of fact by the broker or dealer in
its assertion would likely result in an adverse opinion on one or more
of the broker's or dealer's assertions. As the examination standard
provides requirements relating to adverse opinions, no further changes
were made based on this comment. Furthermore, as stated in the
proposing release, if the auditor believes that additional information
in the compliance report contains a material misstatement of fact, the
auditor should discuss the matter with management of the broker or
dealer. If, after discussing the matter with management, the auditor
concludes that a material misstatement of fact remains, the auditor
should notify management and the audit committee of the auditor's views
concerning the information.
---------------------------------------------------------------------------

    \103\ See paragraph (d)(3) of SEC Rule 17a-5.
---------------------------------------------------------------------------

Appendix B. Considerations for Brokers and Dealers With Multiple
Divisions or Branches

    When a broker or dealer conducts its operations through multiple
divisions and branch offices, the examination standard includes, in
Appendix B, a requirement for the auditor to determine the extent to
which examination procedures should be performed at selected divisions
or branches to obtain sufficient appropriate evidence to support the
conclusions expressed in the auditor's examination report. This
includes determining the divisions or branches at which to perform
examination procedures, as well as the nature, timing, and extent of
the procedures to be performed at those individual divisions or
branches. The same requirements were included in the body of the
proposed examination standard.
    One commenter recommended certain additional factors that should be
taken into account when determining the extent of the examination
procedures to be performed at divisions or branches, including
judgments about materiality of the division or branch and the
similarity of operations over compliance for different divisions or
branches. These factors were considered during the development of the
examination standard. The requirement in the examination standard for
the auditor to take into account the degree to which the financial
responsibility rules relate to activities at the division or branch
level is broader than judgments based solely on the materiality of a
specific division. Adding another factor regarding materiality within
paragraph 13 of the examination standard might limit an auditor's
consideration of the procedures to be performed to only quantitative
factors rather than risks related to non-compliance. As such, this
factor has not been included in the examination standard.
    One commenter recommended including the similarity of operations
over compliance for different divisions or branches as a factor within
the examination standard. Similar to the discussion in the preceding
paragraph, the requirement in the examination standard for the auditor
to take into account the degree to which the financial responsibility
rules relate to activities at the division or branch level includes
considerations regarding the similarity of operations over compliance

for different divisions or branches. Including this factor within
paragraph 13 of the examination standard might limit the auditor's
consideration of the procedures to be performed to identify differences
between different divisions or branches, rather than assessing the risk
that different divisions or branches with similar operations over
compliance might have instances of non-compliance.

Other Comments

Use of the Work of Other Auditors
    Some commenters stated that situations could exist in which the
auditor that is engaged to perform an examination engagement might use
the work of other auditors. Those commenters stated that the
examination standard should include a reference to AU sec. 543, Part of
Audit Performed by Other Independent Auditors. Other commenters stated
that references to the Board's auditing standards were inappropriate
within the attestation standards. By its terms, AU sec. 543 applies
when one auditor uses the work and reports of another auditor of the
financial statements of a component. As this situation does not apply
to a compliance examination engagement, the standard does not refer to
AU sec. 543. Nonetheless, auditors can use the work of other auditors
if such work is performed under their supervision.
Interaction With an Audit of Internal Control Over Financial Reporting
    Some commenters stated that additional guidance relating to the
relationship between internal control over financial reporting and
Internal Control Over Compliance would be beneficial. Those commenters
stated that while SEC Proposed Rule 17a-5 is clear that the attestation
reports do not extend to internal control over financial reporting,
there may be certain controls over financial reporting that could
overlap with Internal Control Over Compliance with the financial
responsibility rules.
    Several commenters stated that the Board should coordinate with the
SEC to provide further guidance regarding the relationship between the
evaluation of Deficiencies in Internal Control Over Compliance and the
evaluation of Material Weaknesses and significant deficiencies in
internal control over financial reporting. The SEC Release contains
relevant discussion regarding the interaction between Internal Control
Over Compliance and internal control over financial reporting.\104\
---------------------------------------------------------------------------

    \104\ See the SEC Release at 38, which notes, among other
things, that internal control over financial reporting is focused on
the reliability of financial reporting and preparation of financial
statements in accordance with generally accepted accounting
principles, whereas the compliance report should focus on oversight
of net capital, custody arrangements, and protection of customer
assets, and, therefore should be focused on compliance with the
financial responsibility rules.
---------------------------------------------------------------------------

Attestation Standard No. 2, Review Engagements Regarding Exemption
Reports of Brokers and Dealers
    As previously described, the review standard has been designed
specifically for an auditor's review of statements made by a broker or
dealer in an exemption report required by the Commission's amendments
to SEC Rule 17a-5.
    Briefly, certain brokers and dealers claim exemption from the
Commission's requirements contained in SEC Rule 15c3-3, the SEC rule
relating to the custody of customer funds, pursuant to exemption
provisions contained in paragraph (k) of SEC Rule 15c3-3 (the
``exemption provisions''). In the exemption report, the broker or
dealer identifies (i) the exemption provision of paragraph (k) of SEC
Rule 15c3-3 under which the broker or dealer claimed exemption from the
SEC's custody requirements (the ``identified exemption provisions''),
and (ii) states that the broker or dealer met the exemption provisions
throughout the most recent fiscal year without exception or, if
applicable, states that exceptions to the identified exemption
provisions were identified, including a description of any such
exceptions and the approximate date on which the exception existed. SEC
Rule 17a-5 requires the broker or dealer to engage an independent
public accountant registered with the PCAOB to review, and
independently report on, the statements in the broker's or dealer's
exemption report.
    Because brokers and dealers claiming an exemption from SEC Rule
15c3-3 requirements under paragraph (k) of that rule might have access
to customer funds, a review engagement focusing on the identification
of exceptions to the exemption provisions claimed by brokers and
dealers is important to the protection of investors. Notably, a recent
PCAOB report on the progress of its interim inspection program of
broker and dealer audits noted that in a significant number of audits
of brokers and dealers that claimed an exemption from SEC Rule 15c3-3,
auditors did not perform sufficient procedures to ascertain that the
broker or dealer complied with the conditions of the exemption.\105\
The review standard includes specific procedures for auditors
performing compliance reviews of a broker's or dealer's assertions in
an exemption report with an emphasis on coordination with the auditor's
work on the financial statement audit and the audit procedures
performed relating to supplemental information. This approach should
enhance overall audit effectiveness and also help avoid unnecessary
duplication of work.
---------------------------------------------------------------------------

    \105\ See Second Report on the Progress of the Interim
Inspection Program Related to Audits of Brokers and Dealers, PCAOB
Release No. 2013-006 (August 19, 2013), at 9.
---------------------------------------------------------------------------

    The following discussion provides background regarding the review
standard, including significant comments received on the proposed
review standard and changes made to the standard.
Overview of SEC Rule 17a-5 and Related Changes
    As amended by the Commission, SEC Rule 17a-5 includes modifications
from the SEC's proposed amendments, including a number of changes that
focus the auditor more directly on the exemption provisions claimed by
the broker or dealer and the identification of any exceptions. These
modifications resulted in corresponding changes to the review standard.
Principally, the changes involve:
     The introduction of certain terms, including ``exemption
provisions,'' and ``exceptions;''
     Changes to the broker's or dealer's assertions, as set
forth in SEC Rule 17a-5, to include more detailed information regarding
the exemption provision claimed asserted by the broker or dealer and
any exceptions identified; and
     Changes to the auditor's reporting requirements, and the
example report, including requirements for auditors to modify their
reports in situations in which the broker or dealer fails to disclose
an exception in the exemption report.
    As noted above, the review standard was designed specifically to
implement the auditor's requirements in SEC Rule 17a-5. The review
standard establishes requirements that apply when an auditor is engaged
to perform an exemption review of the statements made by a broker or
dealer in an exemption report prepared pursuant to SEC Rule 17a-5.
    Paragraph 2 states that SEC Rule 17a-5 requires a broker's or
dealer's exemption report to contain the following statements \106\ by
the broker or dealer:
---------------------------------------------------------------------------

    \106\ See paragraph (d)(4) of SEC Rule 17a-5.
---------------------------------------------------------------------------

    a. A statement that identifies the exemption provisions under which
the

broker or dealer claimed an exemption from SEC Rule 15c3-3;
    b. A statement that the broker or dealer (1) met the identified
exemption provisions throughout the most recent fiscal year without
exception or (2) met the identified exemption provisions throughout the
most recent fiscal year except as described in the exemption report;
and
    c. If applicable, a statement that identifies each exception during
the most recent fiscal year in meeting the identified exemption
provisions (an ``exception'') and that briefly describes the nature of
each exception and the approximate dates on which the exception
existed.
    The changes reflected in SEC Rule 17a-5 to include exceptions to
the exemption provisions in the exemption report did not result in
significant changes to the procedural requirements in the proposed
review standard. The review standard, similar to the proposed review
standard, requires the auditor to state a conclusion regarding whether,
based upon the results of the review procedures, the auditor is aware
of any material modifications that should be made to the broker's or
dealer's assertions for the assertions to be fairly stated, in all
material respects.\107\ To state such a conclusion, the auditor must
plan and perform the review engagement to obtain appropriate evidence
that is sufficient to obtain moderate assurance about whether one or
more conditions exist that would cause one or more of the broker's or
dealer's assertions not to be fairly stated, in all material respects.
---------------------------------------------------------------------------

    \107\ The review standard largely carries forward the
requirement from prior SEC Rule 17a-5 that the independent public
accountant engaged by the broker or dealer ``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.'' See
the SEC Release at 72.
---------------------------------------------------------------------------

Moderate Assurance
    The requirement that the auditor obtain moderate assurance \108\ to
support his or her opinion has not been changed from the Board's
proposal. The approach taken in the review standard is in contrast to
the examination standard, in which the auditor obtains reasonable
assurance to support his or her opinion on the broker's or dealer's
assertions. In the review engagement contemplated by the review
standard, the auditor must obtain moderate assurance regarding the
broker's or dealer's assertions.
---------------------------------------------------------------------------

    \108\ Obtaining moderate assurance in a review engagement is
consistent with both existing PCAOB standards and the SEC Release.
AT sec. 101.55 describes a review as an attest engagement designed
to provide a moderate level of assurance. See the SEC Release at 88,
which states that a ``moderate level of assurance [is] contemplated
by the required review.''
---------------------------------------------------------------------------

    Review engagements typically involve the performance of inquiries
and analytical procedures,\109\ and the auditor's conclusions typically
are expressed in the report in the form of negative assurance.\110\
---------------------------------------------------------------------------

    \109\ AT sec. 101.55 states that ``[i]n an attest engagement
designed to provide a moderate level of assurance (referred to as a
review), the objective is to accumulate sufficient evidence to
restrict attestation risk to a moderate level. To accomplish this,
the types of procedures performed generally are limited to inquiries
and analytical procedures (rather than also including search and
verification procedures).''
    \110\ See AT sec. 101.68.
---------------------------------------------------------------------------

    The proposing release noted that, in a review engagement covered by
the proposed review standard, analytical procedures are not feasible
for evaluating compliance with the exemption conditions, as the
conditions are based on activities of the broker or dealer rather than
on financial statement amounts. Thus, the review standard establishes
specific procedural requirements that are commensurate with the
responsibility to obtain moderate assurance. This approach is
consistent with AT sec 101.55-.56 which states that ``. . . there will
be circumstances in which inquiry and analytical procedures . . .
cannot be performed. . . . In [this] circumstance, the practitioner
should perform other procedures that he or she believes can provide him
or her with a level of assurance equivalent to that which inquiries and
analytical procedures would have provided.''
    Commenters generally stated that the requirements in the review
standard were appropriate for obtaining moderate assurance. Further,
some commenters stated that the term ``moderate assurance'' as used in
the review standard is consistent with how the term ``moderate
assurance'' is presently used in practice and with how auditors are
currently performing engagements to obtain moderate assurance.
    One commenter stated that the review standard could clarify that
the auditor plans and performs the review engagement in the context of
obtaining a moderate level of assurance. In considering this comment,
the Board noted that the objective of the review standard states ``. .
. the auditor must plan and perform the review engagement to obtain
appropriate evidence that is sufficient to obtain moderate assurance. .
. .'' As such, additional clarification is not necessary.
    One commenter stated that an ``agreed-upon procedures'' engagement
would be more appropriate than a review engagement for a broker's or
dealer's assertion that it is exempt from SEC Rule 15c3-3. SEC Rule
17a-5 requires a broker or dealer that claimed exemption from the
requirements of SEC Rule 15c3-3 to file a report from their independent
public accountants that includes the results of a review of the
broker's or dealer's assertions. As adopted, the review standard
establishes requirements that are designed specifically to provide
auditors with a standard for performing the review required by SEC Rule
17a-5.
Performing the Review Engagement (Paragraphs 5-14 of Attestation
Standard No. 2)
General Requirements (Paragraphs 5-6 of Attestation Standard No. 2)
    Paragraphs 5 and 6 of the review standard set forth general
requirements for an auditor performing the review standard. The Board
did not receive significant comments on the general requirements of the
proposed review standard. As such, the general requirements are being
adopted largely as proposed.
    Paragraph 5 of the review standard requires that an auditor
performing a review engagement have adequate technical proficiency in
attestation engagements, obtain an understanding of the exemption
conditions and other rules and regulations that are relevant to the
broker's or dealer's assertion, determine the auditor's compliance with
independence and ethics requirements,\111\ and exercise due
professional care.
---------------------------------------------------------------------------

    \111\ Determining the auditor's compliance with independence and
ethics requirements includes determining whether the auditor
complied with relevant requirements of the PCAOB and the SEC.
Paragraph (f)(1) of SEC Rule 17a-5 requires the auditor to be
independent in accordance with 17 CFR 210.2-01.
---------------------------------------------------------------------------

    The proposed review standard included a footnote which stated that
``due professional care'' referred to in that paragraph was the same
term in paragraph .40 of AT sec. 101. One commenter stated that while
they did not disagree with the meaning of ``due professional care,''
they believe that referencing AT sec. 101 from the review standard may
be confusing, especially as AT sec. 101 would not be applicable to
engagements in which the review standard is applicable. In response, a
note has been added to state that due professional care imposes a
responsibility on each engagement team member to comply with the review
standard and that the exercise of due

professional care requires critical review at every level of
supervision of the work done and the judgment exercised by those
assisting in the engagement, including the preparation of the report. A
footnote to that note states that the auditor's responsibility to
exercise due professional care is consistent with the description in
paragraphs .40-.41 of AT sec. 101.
    With respect to documentation, the review engagement is subject to
the requirements of Auditing Standard No. 3, which applies to
engagements conducted pursuant to the standards of the PCAOB. Auditing
Standard No. 3 states that as audit documentation is the written record
that provides the support for the representations in the auditor's
report, it should demonstrate that the engagement complied with the
standards of the PCAOB.\112\ A note has been added to paragraph 5 of
the review standard to remind auditors of their responsibility to
comply with Auditing Standard No. 3.
---------------------------------------------------------------------------

    \112\ See paragraph 4 of Auditing Standard No. 3.
---------------------------------------------------------------------------

Review Procedures (Paragraphs 8-10 of Attestation Standard No. 2)
    The review standard requires the auditor to perform procedures
consistent with a review engagement; however, the procedures have been
tailored for the exemption report required by SEC Rule 17a-5.
Nature, Timing, and Extent of Procedures (Paragraph 9 of Attestation
Standard No. 2)
    Under the proposed review standard, the nature, timing, and extent
of the review procedures were dependent on certain risk factors and
evidence about the broker's or dealer's compliance with the exemption
conditions or about the effectiveness of controls over the exemption
conditions obtained from the audit of the financial statements and the
audit procedures performed on supplemental information. For example,
one risk factor is potential non-compliance associated with related
parties. Risks associated with related parties that are investment
advisors or with which the broker or dealer has a custodial or clearing
relationship may be especially relevant to the exemption provisions.
    Evidence about the broker's or dealer's compliance with the
exemption provisions or about the effectiveness of controls over the
exemption provisions obtained from the audit of the financial
statements and the audit procedures performed on supplemental
information also affect the nature, timing, and extent of the necessary
inquiries and other review procedures. For example, if the broker or
dealer claims an exemption under Rule 15c3-3(k)(1), the auditor, among
other things, needs to obtain evidence that the broker's or dealer's
transactions are limited to those in redeemable securities of
investment companies or of interests or participations in an insurance
company separate account.\113\ Audit procedures regarding the broker's
or dealer's investment inventory or investment transactions related to
the broker's or dealer's trading for its own account, including
confirmation of investment inventory with the custodian and testing
investment transactions, can provide evidence relevant to the broker's
or dealer's compliance with these exemption conditions.
---------------------------------------------------------------------------

    \113\ Paragraph (k)(1) of SEC Rule 15c3-3, states that ``the
provisions of [Rule 15c3-3] shall not be applicable to a broker or
dealer meeting all of the following conditions:
    (i) His dealer transactions (as principal for his own account)
are limited to the purchase, sale, and redemption of redeemable
securities of registered investment companies or of interests or
participations in an insurance company separate account, whether or
not registered as an investment company; except that a broker or
dealer transacting business as a sole proprietor may also effect
occasional transactions in other securities for his own account with
or through another registered broker or dealer;
    (ii) His transactions as broker (agent) are limited to: (a) The
sale and redemption of redeemable securities of registered
investment companies or of interests or participations in an
insurance company separate account, whether or not registered as an
investment company; (b) the solicitation of share accounts for
savings and loan associations insured by an instrumentality of the
United States; and (c) the sale of securities for the account of a
customer to obtain funds for immediate reinvestment in redeemable
securities of registered investment companies; and
    (iii) He promptly transmits all funds and delivers all
securities received in connection with his activities as a broker or
dealer, and does not otherwise hold funds or securities for, or owe
money or securities to, customers.
    (iv) Notwithstanding the foregoing, this section shall not apply
to any insurance company which is a registered broker [or] dealer,
and which otherwise meets all of the conditions in paragraphs
(k)(1)(i), (ii), and (iii) of this section, solely by reason of its
participation in transactions that are a part of the business of
insurance, including the purchasing, selling, or holding of
securities for or on behalf of such company's general and separate
accounts.''
---------------------------------------------------------------------------

    As another example, if the broker or dealer claims exemption under
section (k)(1) of Rule 15c3-3, the auditor needs to obtain evidence
about whether the broker or dealer promptly transmits all funds and
delivers all securities received in connection with his activities as a
broker or dealer, and does not otherwise hold funds or securities for,
or owe money or securities to, customers.\114\ Audit procedures
regarding customer trade and transaction activities can provide
evidence relevant to these exemption provisions.
---------------------------------------------------------------------------

    \114\ See paragraph (k)(1)(iii) of SEC Rule 15c3-3.
---------------------------------------------------------------------------

    Other procedures performed during the audit that are relevant to
the broker's or dealer's compliance with the exemption provisions
include testing of specially designated cash accounts and reading
clearing agreements between the broker or dealer and clearing brokers
and dealers in connection with testing trade fee or commission revenues
and expenses.\115\
---------------------------------------------------------------------------

    \115\ Refer to ``Relationship Between the Examination Engagement
and the Audit of the Financial Statements and Audit Procedures
Performed on Supplemental Information'' for further discussion.
---------------------------------------------------------------------------

    One commenter recommended incorporating the discussion in the
proposing release relating to the risk of fraud into the review
standard to provide further guidance. The proposing release stated that
in considering the risk of fraud relevant to the exemption conditions,
the auditor also considers whether the broker or dealer has
misrepresented its activities, for example, the broker or dealer claims
to be operating as a non-carrying broker or dealer but, based on other
evidence appears to hold customer funds or securities. The Board
considered this comment and determined, as it has done in other
projects, to include performance requirements in the standard and to
provide additional discussion and examples in the release. Therefore,
the release discussion regarding the risk of fraud has not been
incorporated into the review standard. The request for guidance
regarding the risk of fraud may be taken into account if additional
guidance is issued.
    The Board did not receive extensive comment on these requirements.
Two commenters stated that the factors are appropriate. In general,
these requirements are being adopted substantially as proposed.
Review Procedures (Paragraph 10 of Attestation Standard No. 2)
    Paragraph 10 of the review standard sets forth the required
procedures for the review engagement. Specifically, the procedures
required by the standard are consistent with a review engagement,
including making inquiries of management and relevant personnel of the
broker or dealer; reading relevant reports from internal auditors or
regulatory correspondence; evaluating evidence from the audit of the
financial statements and the audit procedures performed on supplemental
information; and performing additional procedures for identified
exceptions.
    While the review standard requires the auditor to perform
procedures

consistent with a review engagement, the procedures in the standard
have been modified in a number of ways to reflect changes made to SEC
Rule 17a-5, including to reflect terms used in SEC Rule 17a-5. The
following discussion highlights some of the key aspects of, comments
on, and changes made to, the required review procedures.
    Commenters generally supported the requirements as proposed.
However, one commenter stated the proposed review standard does not
clearly describe the procedures or the extent of evidence necessary to
obtain moderate assurance. Another commenter stated that the language
in paragraph 10.h. of the proposed review standard, ``perform other
procedures as necessary in the circumstances to obtain moderate
assurance,'' is an overly broad requirement.
    As previously discussed, obtaining moderate assurance in a review
engagement is consistent with both existing PCAOB standards and the SEC
Release. AT sec. 101.55 describes a review as an attest engagement
designed to provide a moderate level of assurance. The SEC Release
states that a ``moderate level of assurance [is] contemplated by the
required review.'' \116\ The procedures required by the review standard
have been designed to assist the auditor in obtaining moderate
assurance in a review engagement. These procedures largely focus on
making inquiries and reading information relevant to the broker's or
dealer's assertions. In the Board's view, such procedures are
consistent with AT sec. 101.56, given that analytical procedures would
not provide relevant evidence in light of the broker's or dealer's
assertions required by SEC Rule 17a-5. For example, paragraph 10.g. of
the review standard states that in performing the review engagement,
the auditor should evaluate whether the evidence obtained and the
results of the procedures performed in the audit of the financial
statements and the audit procedures performed on supplemental
information corroborate or contradict information in the broker's or
dealer's assertions. Further, paragraph 10.h. of the review standard
has been revised to state that in performing the review engagement, the
auditor should perform other procedures as necessary in the
circumstances to obtain moderate assurance regarding whether a material
modification should be made to the broker's or dealer's assertions for
the assertions to be fairly stated, in all material respects.
---------------------------------------------------------------------------

    \116\ See the SEC Release at 88.
---------------------------------------------------------------------------

    One commenter stated that, while the review procedures and the
matters affecting their nature, timing, and extent are, for the most
part, appropriate for an engagement to obtain a moderate level of
assurance, they did have certain specific recommendations, including
clarifying the note in paragraph 10.g. of the review standard to
explicitly indicate that the examples of procedures are those that may
be performed during the audit of the financial statements. The Board
considered this comment and agrees that such a revision would clarify
that the note is referring to examples of procedures performed during
the audit of the financial statements that might provide relevant
evidence to the review engagement. As such, the note to paragraph 10.g.
of the review standard has been revised.
    In addition, if the broker or dealer has sent to or received
correspondence from the SEC or the broker's or dealer's DEA that is
relevant to compliance with the exemption conditions, the review
standard includes a requirement for the auditor to read such
correspondence and, when necessary in the circumstances, make inquiries
of the regulatory agencies. These procedures can provide the auditor
with relevant information about a broker's or dealer's compliance with
the exemption provisions. Under the circumstances when a need arises to
make inquiries of the regulatory agencies, the Board acknowledges that
auditors may need authorization from the broker or dealer before
contacting the regulatory authority.
    One commenter suggested that the Board provide guidance related to
the interaction between auditors and a company's regulatory examiners
consistent with the AICPA Audit and Accounting Guide for Depository and
Lending Institutions: Banks and Savings Institutions, Credit Unions,
Finance Companies and Mortgage Companies. The guidance in that
publication is specific to the interaction between the auditor and
federal bank examiners, and might differ from the DEAs of the broker or
dealer. As such, additional requirements in this area have not been
included in the review standard.
Evaluating the Results of the Review Procedures (Paragraphs 11-12 of
Attestation Standard No. 2)
    Under paragraph 11 of the review standard, the auditor should
evaluate whether information has come to the auditor's attention that
cause one or more of the broker's or dealer's assertions not to be
fairly stated, in all material respects. For example, a broker's or
dealer's failure to disclose an exception in the exemption report would
cause the assertion not to be fairly stated, in all material respects,
which would require modification of the review report. This paragraph
has been modified to align with the amendments to SEC Rule 17a-5.
    Additionally, the proposed standard required the auditor to perform
additional procedures if information came to the auditor's attention
that indicated that one or more instances of non-compliance might exist
that might cause the broker's or dealer's assertion not to be fairly
stated or if the auditor had substantial doubt about the assertion. The
review standard has been revised to align with the requirements in SEC
Rule 17a-5.
    One commenter requested clarification of the relationship between
paragraphs 10.h. and 12 of the review standard. Those two requirements
address different situations, as discussed below.
    As previously noted, paragraph 10.h. of the review standard
requires auditors to perform other procedures as necessary in the
circumstances to obtain moderate assurance. This applies when the
auditor determines the nature, timing, and extent of review procedures
to be performed, such as in planning the review.
    Paragraph 12 of the review standard applies when information comes
to the auditor's attention during the engagement indicating that the
broker's or dealer's assertions might not be fairly stated or if the
auditor has substantial doubt about the assertion. Pursuant to
paragraph 12, the auditor in those situations is required to perform
additional procedures to address the matter. Performing the review with
due professional care requires an auditor conducting a review to take
appropriate actions when becoming aware of exceptions to the exemption
provisions not included in the broker's or dealer's assertion or when
substantial doubt remains. The phrase ``substantial doubt'' has the
same meaning as the phrase ``substantial doubt'' in paragraph 35 of
Auditing Standard No. 14, which states that if the auditor has not
obtained sufficient appropriate audit evidence about a relevant
assertion or has substantial doubt about a relevant assertion, the
auditor should perform procedures to obtain further audit evidence to
address the matter. In the context of a review engagement, these
additional procedures could include, but are not limited to, making
additional inquiries, reading documents, or

performing search and verification procedures, as necessary.\117\
---------------------------------------------------------------------------

    \117\ See, e.g., AT sec. 101.56.
---------------------------------------------------------------------------

    One commenter recommended incorporating the examples in the
preceding paragraph, e.g., making additional inquiries, reading
documents, or performing search and verification procedures, as
necessary, and the discussion in AT sec. 101.56, into the review
standard. That discussion and the examples have not been included in
the review standard as they are provided to illustrate the nature of
procedures that might be appropriate in such circumstances. Including
these as examples in the review standard might limit auditors'
consideration of additional procedures to only these procedures, when
other procedures might be appropriate.
Obtaining a Representation Letter (Paragraphs 13-14 of Attestation
Standard No. 2)
    The review standard includes a requirement for the auditor to
obtain written representations from management of the broker or dealer
that relate to the review engagement. The purpose of such
representations is to provide the auditor with necessary information
for, and context regarding, the engagement. The auditor should not rely
inappropriately on management's representations.
    The review standard also provides that the failure to obtain
written representations from management, including management's refusal
to furnish them, constitutes a limitation on the scope of the review
engagement. If a limitation on the scope of the review engagement
exists, the auditor should withdraw from the engagement or should
modify the review report.\118\ Additionally, the review standard also
includes a list of written representations that the auditor should
obtain from management.
---------------------------------------------------------------------------

    \118\ See paragraph 20 of the review standard for auditor
requirements when a scope limitation exists.
---------------------------------------------------------------------------

    Commenters stated that obtaining representations from management is
a necessary part of the auditor's ability to express an opinion. One
commenter recommended that the list of required written representations
include a representation from management that acknowledges its
responsibility for the assertions in the exemption report. The
suggested additional representation has been included in the review
standard.
    Further, in the review standard, several of the representations
were updated to align with the language in SEC Rule 17a-5.
Communication Requirements (Paragraph 15 of Attestation Standard No. 2)
    The review standard requires the auditor to communicate to
management and to the audit committee any exceptions to the exemption
provisions identified by the auditor or information that causes the
broker's or dealer's assertions about its exemption provisions not to
be fairly stated, in all material respects. In addition, rather than
defining the term audit committee, the review standard states that the
term ``audit committee'' has the same definition as that in Auditing
Standard No. 16.
    The Board did not receive significant comments on the communication
requirements included in the proposed review standard. However, the
communication requirements in the standard have been modified to align
closely with SEC Rule 17a-5. Additionally, a note has been added to
paragraph 15 of the review standard reminding auditors of their
obligation to comply with the requirements of paragraph (h) of SEC Rule
17a-5.\119\
---------------------------------------------------------------------------

    \119\ See also the discussion of the notification requirements
in the SEC Release at 101-107.
---------------------------------------------------------------------------

Reporting on the Review Engagement (Paragraphs 16-18 of Attestation
Standard No. 2)
    The review standard includes requirements for the auditor's review
report to include certain elements that are important for a reader of
the review report to understand regarding the auditor's
responsibilities. This includes a statement that the review was
conducted in accordance with the standards of the PCAOB and,
accordingly, includes inquiries and other required procedures to obtain
evidence about the broker's or dealer's compliance with the exemption
provisions. These are largely the same elements as in the proposed
standard.
    The review standard includes an example of the auditor's standard
review report when the broker or dealer asserted that it met the
identified exemption provisions throughout the most recent fiscal year
without exception and an example of the auditor's standard review
report when the broker or dealer includes exceptions to the exemption
provisions in the exemption report. A change was made to the review
results paragraph in the example review report to align the reporting
language more closely to the corresponding reporting element, which was
not modified from the proposed review standard.
    Some commenters stated concerns similar to those for the
examination report regarding the use of the review report as a legal
determination, interpretation of rules and regulations, restrictions on
use of the review report, and limitations of an engagement to obtain
moderate assurance. When the auditor is engaged to perform a review
engagement, it is necessary for the auditor to read and make judgments
regarding the application of regulatory requirements, as applicable to
the engagement. The review report issued pursuant to the review
standard does not provide a legal determination, nor does it purport to
provide a legal determination, of a broker's or dealer's compliance
exemption provision. However, such a report may be useful to legal
counsel or others in making such determinations.
Modifications of the Report (Paragraphs 19-20 of Attestation Standard
No. 2)
    The review standard requires that if one or more of the broker's or
dealer's assertions are not fairly stated, in all material respects,
the auditor must modify the review report to describe the reasons why
the assertions are not fairly stated, in all material respects. If the
broker's or dealer's assertion is not fairly stated because of one of
more omitted exceptions, the auditor's review report should disclose
each omitted exception.
    Paragraph 20 of the review standard sets forth circumstances
involving scope limitations. Under the review standard, if the auditor
cannot perform the procedures required by the review standard or other
procedures that the auditor deems necessary in the circumstances, the
review is incomplete because of the scope limitation. An incomplete
review is not a sufficient basis for stating a conclusion regarding the
broker's or dealer's assertions. In the case of a scope limitation, the
auditor should withdraw from the engagement or should modify the review
report to:
    a. Describe the scope limitation and any review procedures deemed
necessary by the auditor that have been omitted and the reason for
their omission;
    b. State that the auditor does not express any form of assurance on
the broker's or dealer's assertions; and, if applicable,
    c. Describe the circumstances which cause one or more of the
broker's or dealer's assertions not to be fairly stated, in all
material respects.
    One commenter stated that auditors should use judgment in drafting
an appropriate modification to the review report. Other commenters
stated that the attestation standards should contain

examples of report modifications. The standard sets forth the necessary
reporting elements for modified reports. Additional report examples may
be considered if guidance is issued in the future.
    One commenter questioned the appropriateness of the requirement in
paragraph 20 of the proposed review standard for the auditor to
describe the omitted procedures and the reason for their omission. The
commenter stated that as the reason for the omission of the review
procedures is required in the description of the scope limitation
itself, describing the omitted review procedures might overshadow the
scope limitation. The commenter recommended that it would be more
appropriate to generally describe the effect of the scope limitation on
the engagement, without providing a list of omitted procedures that may
have been considered necessary. Including in the review report a
description of the scope limitation, the omitted procedures, and the
reason for their omission are important elements of a modified review
report given the nature of the procedures and the specificity of the
exemption provisions. The discussion of the omitted procedures
generally would provide the reader with additional information beyond
the description of the scope limitation. As such, this recommendation
has not been incorporated into the review standard.
    The same commenter also recommended that the review standard
address the auditor's responsibility as it relates to report
modifications when management's assertion is improperly presented or
contains additional information. That commenter suggested that, in such
circumstances, an explanatory paragraph should be included in the
auditor's report. Paragraph 19 of the review standard requires the
auditor to modify the review report to describe the reasons the
assertions are not fairly stated, in all material respects, if one or
more of the broker's or dealer's assertions are not fairly stated. This
would include circumstances in which management's assertion is
improperly presented, and other PCAOB standards address additional
information.\120\
---------------------------------------------------------------------------

    \120\ See, e.g., AU sec. 550, Other Information in Documents
Containing Audited Financial Statements.
---------------------------------------------------------------------------

Amendments
Auditing Standard No. 3
    The Board is adopting certain amendments to Auditing Standard No.
3, Audit Documentation, to clarify that its requirements apply to
examination engagements and review engagements. Auditing Standard No. 3
establishes general requirements for documentation the auditor should
prepare and retain in connection with engagements conducted pursuant to
standards of the PCAOB, including the attestation standards of the
PCAOB. The Board is amending Auditing Standard No. 3 to help auditors
properly apply the relevant requirements in Auditing Standard No. 3 to
attestation engagements, including the attestation engagements covered
by the attestation standards. For example, paragraph 6 of Auditing
Standard No. 3 includes a requirement for the auditor to document
procedures performed, evidence obtained, and conclusions reached with
respect to relevant financial statement assertions. An amendment to
footnote 2 of paragraph 6 clarifies that, with respect to an engagement
conducted pursuant to the attestation standards of the PCAOB, the
relevant assertions are the assertions expressed by management or the
responsible party regarding the subject matter of the attestation
engagement.
    In addition, paragraph 12 of Auditing Standard No. 3 includes
requirements regarding significant findings or issues and provides
certain examples of significant findings or issues. Further, paragraph
13 of Auditing Standard No. 3 requires the auditor to identify all
significant findings or issues in an engagement completion document.
    The Board did not receive comments requiring revision to the
amendments to Auditing Standard No. 3. As such, the amendments are
adopted largely as proposed.
Auditing Standard No. 7
    The Board is adopting certain amendments to Auditing Standard No.
7, Engagement Quality Review, to extend the requirements for an
engagement quality review and concurring approval of issuance for the
examination engagements and review engagements of brokers and dealers
covered by these attestation standards. The proposal also included
amendments that set forth certain procedures to be applied in an
engagement quality review of the examination and review under these
attestation standards.
    Commenters expressed a range of views. Some commenters generally
supported the engagement quality review requirement for these
attestation engagements as well as the required procedures. One
commenter did not support requiring an engagement quality review for
either an examination engagement or a review. Other commenters did not
support engagement quality reviews for review engagements. Some
commenters stated that additional guidance is necessary to implement
the proposed amendments.
    Other commenters stated that as the audit and attestation standards
have been separate bodies of literature, audit and attest standards
should be kept separate. Those comments stated that to promote
compliance with PCAOB standards, they believe that the Board should
continue to maintain this structure. They also believe that the use of
an amendment to adopt such significant changes in the literature may
not sufficiently take into account a broader consideration of the
affected engagements. For those firms that do not audit brokers or
dealers, such changes also may go unnoticed.
    The Board considered the comments received regarding the amendments
to Auditing Standard No. 7 and is adopting the amendments as proposed
for both a compliance examination and a compliance review.
    Given the importance of the attestation engagements to investor
protection and the high level of deficiencies observed by PCAOB
inspection staff in areas that would be covered by the attestation
engagements,\121\ the Board believes that engagement quality reviews
can enhance the consistency of compliance with the SEC's rule. An
effective engagement quality review can increase the likelihood of
identifying significant engagement deficiencies before the examination
or review report is issued. Additionally, the Board took note of the
fact that, in a February 2011 AICPA Peer Review Alert, the AICPA
designated audits of carrying brokers or dealers as a ``must select''
for peer review, recognizing the significant public interest in audits
of such firms.\122\
---------------------------------------------------------------------------

    \121\ See PCAOB Release 2013-006, which reports that PCAOB
inspection staff identified auditing deficiencies in 57 of the 60
audits of brokers and dealers selected for inspection and that
deficiencies in compliance with audit requirements for brokers and
dealers under the Exchange Act that were among the most frequently
noted by PCAOB inspection staff included deficiencies in audit
procedures related to net capital and customer reserve supporting
schedules, compliance with the conditions of the exemption claimed
by the broker or dealer, and the accountant's supplemental report on
material inadequacies. See PCAOB Release 2013-006, Executive
Summary, at ii.
    \122\ See AICPA Peer Review Alert 11-01 (February 2011).
---------------------------------------------------------------------------

    Also, the emphasis in the attestation engagements regarding the
coordination of the attestation engagement with the financial statement
audit should reduce the audit effort required to complete the
engagement quality review. To emphasize the coordination of the

attestation engagement with the financial statement audit in performing
an engagement quality review, the proposed amendment to paragraph 18A
of Auditing Standard No. 7 was modified to reflect that to evaluate
significant judgments made by the engagement team and the related
conclusions reached in forming the overall conclusion on the
attestation engagement and in preparing the engagement report, the
engagement quality review should take into account the procedures
performed in the engagement quality review of the financial statement
audit. The knowledge that the engagement quality reviewer gains from
the engagement quality review of the audit and the specific steps in
paragraph 18A should enable the engagement quality reviewer to identify
whether there are any significant engagement deficiencies, or any
indications of potential significant engagement deficiencies that
warrant further investigation.
Other Areas of Comment
    The Board requested comment from interested parties on all aspects
of the proposal. Several commenters included additional recommendations
that have not yet been discussed. Those suggestions are discussed
below.
Scalability of the Attestation Standards
    The Board requested comment regarding whether the proposed
attestation standards are tailored appropriately for examinations and
reviews related to compliance and exemption reports of brokers and
dealers. Commenters who responded to the question generally agreed that
the proposed attestation standards are tailored appropriately for
examinations and reviews related to compliance and exemption reports of
brokers and dealers. One commenter stated that they generally support
the proposals and noted that the proposed standards had been clearly
aligned with the SEC's proposed rule amendments.
    The Board also requested comment regarding whether the proposed
attestation standards were appropriately scalable based on the size and
complexity of the broker or dealer. Some commenters stated that the
standards are proportionate and appropriately scalable based on the
size and complexity of the broker or dealer, noting that paragraphs 11
and 12 of Attestation Standard No. 1 are particularly helpful. Some
commenters recommended that the Board provide additional guidance,
including specific examples, regarding the application of scalability
to these examination engagements. Other commenters expressed concern
that without such guidance, application of the audit scalability
concept could vary greatly across the audit profession. The requests
for guidance may be taken into account if additional staff guidance is
issued.
Commodity Futures Trading Commission Rules
    One commenter stated that for brokers and dealers that are also
registered as a Futures Commission Merchant with the Commodity Futures
Trading Commission (``CFTC''), it will be necessary for the PCAOB to
recognize and address the requirements related to CFTC Rule 1.16 for
the auditor to report on compliance therewith. The Commission stated in
the SEC Release that its staff ``is in discussions with the CFTC staff
concerning ways to align the reporting and audit requirements for
dually registered broker-dealers/Futures Commissions Merchants with the
goal of coordinating these requirements.'' \123\
---------------------------------------------------------------------------

    \123\ See the SEC Release at 8.
---------------------------------------------------------------------------

Independence
    Several commenters recommended that the discussion in the proposing
release stating that auditors of non-issuer brokers and dealers are not
subject to PCAOB Rules 3521 through Rule 3526 be included in the
attestation standards. On February 28, 2012, the Board proposed
amendments to require that registered firms that audit brokers and
dealers comply with certain of the Board's professional practice
standards including the Board's Rules relating to independence.\124\
The Board will consider relevant comments applicable to the Board's
independence rules in connection with adopting final amendments.
---------------------------------------------------------------------------

    \124\ See Proposed Amendments to Conform PCAOB Rules and Forms
to the Dodd-Frank Act and Make Certain Updates and Clarifications,
PCAOB Release No. 2012-002 (February 28, 2012).
---------------------------------------------------------------------------

Period of the Examination and Review
    Some commenters stated that brokers and dealers should be allowed
to assert compliance with the financial responsibility rules if it can
identify deficiencies, implement effective controls, and test their
operating effectiveness prior to year-end, and if the auditor also can
adequately test the operating effectiveness of the remediated controls.
SEC Rule 17a-5 requires the broker or dealer to assert that Internal
Control Over Compliance was effective during the most recent fiscal
year and as of the end of the most recent fiscal year. While this would
require a broker or dealer to identify in its report Material
Weaknesses in internal control that occurred during the most recent
fiscal year, if those Material Weaknesses are remediated, it would
allow the broker or dealer to assert that Internal Control Over
Compliance was effective as of the end of the most recent fiscal year.
    Some commenters requested clarification about the time period for
the assertion regarding exemption from the requirements of SEC Rule
15c3-3 and indicate that they believe a point-in-time assertion would
be sufficient. SEC Rule 17a-5 requires the broker or dealer to assert
that it met, or met with exception, the identified exemption provisions
in paragraph (k) of SEC Rule 15c3-3 throughout the most recent fiscal
year end. The review standard has been updated to reflect this time
period.
Providing Additional Guidance and Including Examples From the Proposing
Release in the Examination Standard
    Several commenters recommended incorporating the additional
discussion and examples included in the proposing release into the
standard. The examples are not included in the attestation standards.
Those examples were illustrative and did not impose requirements or
define engagement requirements. Additional report examples may be
considered, if guidance is issued in the future.
Other Considerations
Agreed-Upon Procedures Engagements
    SEC Rule 17a-5 largely carries forward the requirement that the
broker or dealer file with SIPC a supplemental report that includes an
accountant's report on applying agreed-upon procedures based on the
performance of the procedures outlined in SEC Rule 17a-5.\125\
---------------------------------------------------------------------------

    \125\ See paragraph (e)(4)(ii) of SEC Rule 17a-5.
---------------------------------------------------------------------------

    These attestation standards do not affect the requirements for
those agreed-upon procedures engagements. Auditors should continue to
look to AT sec. 101, AT sec. 201, Agreed-Upon Procedures, and AT sec.
601,\126\ for the requirements applicable to those engagements.
---------------------------------------------------------------------------

    \126\ See paragraphs .16-.29 of AT sec. 601.
---------------------------------------------------------------------------

Relationship to the Interim Attestation Standards
    In general terms, the requirements in the examination standard are
consistent with the requirements of AT sec. 101 and AT sec. 601.
However, when an auditor performs an engagement pursuant to the
examination standard, AT sec. 101 and AT sec. 601 would not apply. For
this reason, the examination standard includes, for example, a

section on general requirements that are consistent with those in AT
sec. 101.
    The examination standard focuses specifically on performing an
examination of the statements made by a broker or dealer in a
compliance report and allows auditors to perform such engagements
without looking to multiple attestation standards. In addition, the
emphasis in the examination standard on appropriately coordinating the
examination engagement with the audit of the financial statements and
supplemental information should avoid unnecessary redundancy in the
auditor's work.
Economic Considerations, Including Audits of Emerging Growth Companies
Economic Considerations
    As noted above, in developing the attestation standards, the
Board's objective was to consider the SEC's amendments to SEC Rule 17a-
5 and evaluate whether its standards were appropriate for the SEC's
requirements for examinations of compliance reports and reviews of
exemption reports.
    As part of its process, the Board also considered the SEC's
economic analysis related to its amendments to SEC Rule 17a-5. The
SEC's analysis considers the economic effects, including the benefits
and costs, of the new examinations of compliance reports and reviews of
exemption reports that are now required by the SEC to be filed by
registered brokers and dealers pursuant to SEC Rule 17a-5 and includes
considerations relating to efficiency, competition, and capital
formation.\127\
---------------------------------------------------------------------------

    \127\ See the SEC Release, which discusses costs and benefits of
the requirements for examined compliance reports and reviewed
exemption reports at 226-245.
---------------------------------------------------------------------------

    The SEC's economic analysis considered the Board's proposed
attestation standards. As described in the SEC Release, after
considering the views of commenters relating to anticipated costs,
including with respect to the Board's proposed attestation standards,
the SEC concluded that, while the total costs associated with the new
compliance and review requirements would depend on the final PCAOB
standards for attestation engagements, ``as the PCAOB's proposed
standards were tailored to the proposed amendments, nothing in those
standards causes the Commission to change its estimates of the costs
associated with these requirements, or to question that the benefits
will justify the costs.'' \128\ The Board notes that, as adopted, the
new attestation standards are aligned with SEC Rule 17a-5, and most of
the differences between the proposed standards and the attestation
standards, as adopted, result from changes to conform to the SEC's
final amendments to SEC Rule 17a-5.
---------------------------------------------------------------------------

    \128\ See the SEC Release at 241.
---------------------------------------------------------------------------

    In addition to considering the SEC's requirements and economic
analysis, the Board also took into account other related economic
considerations as discussed below.
Economic Baseline
    The SEC made the determination to require brokers and dealers to
include in their annual reports either a compliance report that is
examined by an auditor or an exemption report that is reviewed by an
auditor.
    Therefore, the SEC Release contains a discussion of the economic
baseline in its economic analysis. Aspects of the SEC's discussion of
the baseline that are relevant to the attestation standards include:
     Before the SEC's amendments, Rule 17a-5 required that the
audit under GAAS include a ``review'' of the broker's or dealer's
accounting system, internal accounting control, and procedures for
safeguarding securities.\129\ The scope of the auditor's work was
required to be sufficient to provide reasonable assurance that any
material inadequacies \130\ existing as of the date of the examination
would be disclosed.
---------------------------------------------------------------------------

    \129\ See the SEC Release at 70.
    \130\ Prior to the SEC's amendments, paragraph (g)(3) of Rule
17a-5 described a ``material inadequacy'' in a broker's or 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: (i) Inhibit a broker-dealer from promptly completing
securities transactions or promptly discharging its responsibilities
to customers, other broker-dealers or creditors; (ii) result in
material financial loss; (iii) result in material misstatements of
the broker-dealer's financial statements; or (iv) 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 [(i) through (iii)]
above.'' See the SEC Release at 70, footnote 287.
---------------------------------------------------------------------------

     Before the SEC's amendments, if the broker or dealer was
exempt from the reserve requirements rule, the auditor was required to
ascertain that the conditions of the exemption were being complied with
as of the examination date and that no facts came to the auditor's
attention to indicate that the exemption had not been complied with
during the period since the last examination.
    Under the SEC's amendments, audits of brokers and dealers are now
required to be conducted in accordance with PCAOB standards, the
material inadequacy report has been replaced with an examination of the
compliance report, and the requirement to ascertain compliance with the
exemption conditions has been replaced with a review of the exemption
report.
Consideration of Alternatives and Additional Considerations
    In general, the Board sought to evaluate whether its attestation
standards were appropriate for performing and reporting on the newly
required examinations and reviews. The SEC is a key user of the new
reports, which serve to facilitate the SEC's compliance oversight
function. Accordingly, the Board's standards for those engagements
needed to reflect a compliance focus and needed to be aligned with the
requirements in SEC Rule 17a-5.
    The Board considered two principal alternatives: (1) Issuing
guidance on applying existing PCAOB attestation standards to the new
examination and review engagements, or (2) developing standards
tailored to the requirements of SEC Rule 17a-5. In considering the
first alternative, the Board observed that auditors performing
examinations of compliance reports would need to look to a patchwork of
requirements in existing attestation standards, including AT sec. 101
and AT sec. 601, and apply them to the new examination of the
compliance report and review of the exemption report. This could lead
to more inconsistencies in compliance with the SEC's rule as compared
to a tailored standard that sets forth the necessary procedures for
complying with the SEC's rule.
    The Board preliminarily determined that a broker and dealer
specific approach to examining compliance reports and reviewing
exemption reports that is tailored to the SEC's rule would promote
consistent audit practices and compliance with the SEC's rule because
auditors could more readily determine the procedures necessary to meet
the requirements for reasonable assurance in the examination and
moderate assurance in the review. The greater clarity also can help
facilitate more efficient use of audit resources, which can help
mitigate the associated costs. Since the Board's initial proposal, the
high level of auditing deficiencies observed by PCAOB inspections of
audits of brokers and dealers under pre-existing standards have
underscored the Board's initial concerns about the need for

standards that facilitate more consistent compliance with the SEC's
rule.\131\
---------------------------------------------------------------------------

    \131\ See PCAOB Release 2013-006, which reports that PCAOB
inspection staff identified auditing deficiencies in 57 of the 60
audits of brokers and dealers selected for inspection and that
deficiencies in compliance with audit requirements for brokers and
dealers under the Exchange Act that were among the most frequently
noted by PCAOB inspection staff included deficiencies in audit
procedures related to net capital and customer reserve supporting
schedules, compliance with the conditions of the exemption claimed
by the broker or dealer, and the accountant's supplemental report on
material inadequacies. See PCAOB Release 2013-006, Executive
Summary, at ii.
---------------------------------------------------------------------------

    In developing the new standards, the Board took into account
economic considerations, including taking note of commenters' views on
the proposed attestation standards. The Board's approach is intended to
focus and streamline the auditor's work in order to promote overall
audit effectiveness and avoid duplicative procedures. The Board sought
to ease the transition to the new standards and help lessen the effect
of associated costs by:
     Building on principles and concepts in existing
attestation standards, such as the general requirements in AT sec. 101,
and the risk-based principles for testing controls as set forth in
Auditing Standard No. 5, An Audit of Internal Control Over Financial
Reporting That Is Integrated with An Audit of Financial Statements, and
Auditing Standard No. 13, The Auditor's Responses to the Risks of
Material Misstatement;
     Focusing the auditor's attention on the most important
matters related to the objective of the examination or review, as
applicable, including addressing the risk of misappropriation of
customer assets;
     Requiring coordination of the attestation standards with
the audit of the financial statements and audit procedures on the
supplemental information, to enhance the effectiveness of the
coordinated work and avoid unnecessary duplication of work; \132\ and
---------------------------------------------------------------------------

    \132\ By its terms, SEC Rule 17a-5 requires the financial
statement audit and the compliance examination or review to be
performed by the same auditor. See paragraph (g) of SEC Rule 17a-5.
---------------------------------------------------------------------------

     Establishing risk-based approaches for the examination and
review that are scalable--that is, the required audit effort is
commensurate with the broker's or dealer's size and complexity \133\--
and that facilitate consistent compliance with SEC Rule 17a-5.