misunderstandings or miscommunications should not limit the ability of
the Commission or a DEA to have access to audit documentation or a
broker-dealer's independent public accountant. Further, to the extent a
misunderstanding or miscommunication between a broker-dealer and its
accountant is reflected in the accountant's audit documentation
relating to the broker-dealer, the broker-dealer could clarify the
nature of the misunderstanding or miscommunication to examiners and how
it was rectified if such clarification and rectification is not already
described in subsequent audit documentation.
---------------------------------------------------------------------------

    \856\ See CAI Letter.
---------------------------------------------------------------------------

    The Commission estimated that the one-time hour burden associated
with amending its existing statement and filing the new statement with
the Commission, in order to comply with the proposed amendments, would
be an average of approximately two hours on a one-time basis for each
broker-dealer, as the statement can be continuing in nature.\857\
---------------------------------------------------------------------------

    \857\ See Broker-Dealer Reports, 76 FR at 37596.
---------------------------------------------------------------------------

    As discussed in the PRA, the Commission is revising this estimate
for clearing and carrying broker-dealers, as these broker-dealers will
likely be required to renegotiate their agreements with their
independent public accountants. The Commission estimates that the total
one-time cost associated with this burden is approximately $5.2
million.\858\ Additionally, the Commission believes there will be
postage costs associated with sending the amended statement regarding
the accountant and estimates that each mailing will cost approximately
$0.45, for a total cost of approximately $6,357 for all broker-dealers
on a one-time basis.\859\
---------------------------------------------------------------------------

    \858\ See Section VI.D.1.vi. Based on staff experience, a
broker-dealer that carries customer accounts or clears transactions
likely would have its Controller and an Assistant General Counsel
involved in renegotiating the agreement with auditors, and that
those discussions would take, on average, approximately four hours.
Broker-dealers would likely have an attorney prepare a new
notification of designation of accountant, and that task would take
the attorney, on average, approximately two hours. According to the
SIFMA Report on Management and Professional Earnings in the
Securities Industry, as modified by Commission staff to account for
an 1,800-hour work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead, the hourly cost
of a Controller is approximately $409/hour, the hourly cost of an
Assistant General Counsel is approximately $407/hour, and the hourly
cost of an Attorney is approximately $378/hour. 513 broker-dealers
that carry customer accounts or clear transactions x 4 hours x $409
= $839,268. 513 broker-dealers that carry customer accounts or clear
transactions x 4 hours x $407 = $835,164. 4,709 broker-dealers x 2
hours x $378 = $3,560,004. $839,268 + $835,164 + $3,560,004 =
$5,234,436.
    \859\ See Section VI.D.1.vi. 4,709 broker-dealers x $0.45 cost
for first class postage x 3 mailings = $6,375.15.
---------------------------------------------------------------------------

    In addition, in the proposing release, the Commission estimated
that a carrying or clearing broker-dealer's accountant would charge the
broker-dealer for time its personnel spend speaking with the Commission
or the broker-dealer's DEA or providing them with audit documents and
that, on average, the Commission or the broker-dealer's DEA may speak
with each accountant for approximately five hours per year. Thus, the
Commission estimated that the additional cost of accountant time
associated with this amendment to all clearing and carrying broker-
dealers would be approximately $660,000 annually.\860\ As the
Commission now estimates that the number of carrying or clearing
broker-dealers is 513, the new estimate is approximately $641,250.\861\
---------------------------------------------------------------------------

    \860\ See Section VI.D.1.vii.d. In the proposing release the
Commission multiplied 528 clearing and carrying broker-dealers x 5
hours x $250/hour = $660,000.
    \861\ See Section VI.D.1.vii.d. 513 clearing and carrying
broker-dealers x $1,250 in increased costs per clearing broker-
dealer = $641,250.
---------------------------------------------------------------------------

3. Form Custody
    The newly adopted Form Custody is to be filed quarterly at the same
time that a broker-dealer is required to file its FOCUS Reports. The
form elicits information concerning whether, and if so, how, a broker-
dealer maintains custody of customer assets and, as discussed above,
consolidates information about the broker-dealer's custodial
responsibility and relationships with other custodians in one report so
that the Commission and other securities regulators will be provided
with a comprehensive profile of the broker-dealer's custody practices
and arrangements. This should reduce the likelihood that fraudulent
conduct, including misappropriation or other misuse of investor assets,
can continue undetected. Further, the information provided in Form
Custody should aid in the examination of broker-dealers, because the
examination staff can use the information provided as another tool to
prioritize and plan examinations.
    The Form Custody amendments also should enhance investor confidence
in the ability of the securities regulators to oversee broker-dealers
and broker-dealer custody of investor assets. By establishing a
discipline under which broker-dealers are required to report greater
detail as to their custodial functions, investor perception as to the
safety of their funds and securities held by broker-dealers should
improve. Investors may be more willing to provide capital for
investment. Further, the requirement by broker-dealers to provide
detail as to their custodial practices may prompt them to identify and
correct deficiencies. For example, if a broker-dealer preparing the
information to be disclosed on the form discovers a discrepancy between
its own records and the records of a custodian as to the nature or
quantity of assets held by the custodian, the broker-dealer can act to
resolve the discrepancy before filing the form.
    The Commission estimated that the time required to complete and
file Form Custody would be approximately 12 hours per quarter, or 48
hours per year, on average, for each broker-dealer.\862\ The Commission
did not receive comments regarding this estimate. The Commission now
estimates that there are approximately 4,709 broker-dealers that must
file Form Custody. The Commission therefore estimates that the total
time required to complete and file Form Custody for all 4,709 broker-
dealers is approximately 226,032 hours per year (4,709 broker-dealer
times four responses per year times 12 hours = 226,032 hours). Further,
the Commission estimates that the total cost associated with completing
and filing Form Custody is approximately $69.8 million.\863\
---------------------------------------------------------------------------

    \862\ See Broker-Dealer Reports, 76 FR at 37597.
    \863\ Based on staff experience, a broker-dealer likely would
have a Financial Reporting Manager complete and file Form Custody.
According to the SIFMA Report on Management and Professional
Earnings in the Securities Industry, as modified by Commission staff
to account for an 1,800-hour work-year and multiplied by 5.35 to
account for bonuses, firm size, employee benefits and overhead, the
hourly cost of a Financial Reporting Manager is approximately $309/
hour. 4,709 broker-dealers x 48 hours x $309 = $69,843,888.

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

    One commenter stated that the estimated costs to the industry of
$69,179,670 in the proposing release was ``staggering,'' and that such
costs would likely indirectly be passed on to customers.\864\ The
commenter did not disagree with the estimated cost in the proposing
release; rather, the commenter focused on the size of the total
estimated costs. The Commission notes that the $69 million estimate in
the proposing release and the $69.8 million estimate in this release
are estimates of the aggregate cost to the industry. The average cost
to an individual broker-dealer would be approximately $15,000 per
year.\865\ As an average, the costs incurred by a broker-dealer to
comply with the requirement to file Form Custody will depend on its
size and the complexity of its business activities.
---------------------------------------------------------------------------

    \864\ See IMS Letter. The cost of $69,179,670 was reflected in
the economic analysis in the proposing release. See Broker-Dealer
Reports, 76 FR at 37601. This cost was calculated as an internal
cost of the estimated PRA hours and is the total cost divided among
5,057 firms. Id. at 37601 n.215. This internal cost would amount to
an average of $13,680 per broker-dealer. Id.
    \865\ 1 broker-dealer x 48 hours x $309 = $14,832.
---------------------------------------------------------------------------

    The Commission recognizes that the requirement to file Form Custody
will increase compliance costs for broker-dealers and that these costs
may be passed on to customers. The Commission, however, believes the
investor protection benefits of the Form Custody requirements outweigh
these costs. As noted above, Form Custody is designed to assist
Commission and DEA examiners in identifying potential
misrepresentations relating to broker-dealers' custody of assets.
Further, the requirements to file the form will promote greater focus
and attention to custody practices by requiring that broker-dealers
make specific representations in this regard. The safeguarding of
customer securities and cash held by broker-dealers is of paramount
importance as demonstrated by recent cases where broker-dealers failed
to protect customer securities and cash.\866\
---------------------------------------------------------------------------

    \866\ See, e.g., SEC v. Bernard L. Madoff, et al., Litigation
Release No. 20889 (Feb. 9, 2009).
---------------------------------------------------------------------------

4. Consideration of Burden on Competition, and Promotion of Efficiency,
Competition, and Capital Formation
    As discussed above, incremental costs will result from the annual
reporting requirement amendments, the access to accountant amendments,
and the Form Custody amendments. These incremental costs could result
in higher barriers to entry for broker-dealers as compared with the
baseline that existed prior to the amendments. This could be the case
particularly for carrying broker-dealers given the incremental costs
associated with the compliance report requirements, the applicability
of the access to accountant amendments to carrying and clearing broker-
dealers, and that most of the information elicited in Form Custody
relates to carrying broker-dealer activities.
    The annual reporting requirements have a mixed effect on
competition across broker-dealers. The requirement to prepare and file
a compliance report or exemption report may impose a burden on
competition for smaller carrying broker-dealers to the extent that it
imposes relatively high fixed costs, which would represent a greater
amount of net income for smaller broker-dealers. On the other hand, as
previously noted, a carrying broker-dealer with limited custodial
activities should have to expend less effort to support its statements
in the compliance report than a broker-dealer with more extensive
custodial activities, and the attendant costs should similarly be
lower. While the incremental costs of the annual reporting requirements
may be lower for non-carrying broker-dealers (which generally are
smaller broker-dealers), the costs could disproportionately impact
smaller broker-dealers due to fixed cost components of the cost of
compliance with these requirements.
    The access to accountant amendments may place a burden on carrying
and clearing broker dealers. To the extent that addressing contracts
between auditors and broker-dealers is a fixed cost, the rule may
impact smaller broker-dealers to a greater extent than it will larger
broker-dealers. The amendments should not place a burden on competition
for non-carrying broker-dealers.
    The requirement to file Form Custody could have a burden on
competition because it will increase compliance costs for broker-
dealers. However, the requirement should not have a disproportionate
effect on smaller broker-dealers. Smaller firms will incur fewer costs
to complete Form Custody because less information is required to be
disclosed. For example, broker-dealers that introduce customers on a
fully disclosed basis and do not have custody of customer funds or
assets would leave much of the form blank.
    In sum, the costs of compliance resulting from the requirements in
these amendments should not impose a burden on competition not
necessary or appropriate in furtherance of the purposes of the Exchange
Act and in light of the benefits discussed above.
    Today's amendments are designed to reduce the likelihood that
fraudulent conduct, or lack of appropriate custody procedures or other
internal controls, will jeopardize customer securities and funds held
by broker-dealers. To the extent that the amendments achieve that goal,
investors should be more confident that the customer assets held by
broker-dealers are safe. This in turn may promote capital formation as
investor assets are able to be allocated more efficiently across the
opportunity set.
    One commenter asserted that the proposed amendments ``place
unnecessary regulatory burdens and costs on industry, in general, and
smaller firms, in particular'' and that ``broker-dealers compete
against investment advisers who are not burdened by the same regulatory
requirements,'' including the requirements in the proposed
amendments.\867\ The Commission recognizes, as explained above, that
the amendments adopted today impose costs on broker-dealers that could
result in higher barriers to entry. However, the Commission is of the
opinion that these costs are justified by the numerous and significant
benefits, in particular with respect to protection of customer assets,
described in this economic analysis.
---------------------------------------------------------------------------

    \867\ See IMS Letter.
---------------------------------------------------------------------------

    With respect to the commenter's statement about broker-dealers
competing with investment advisers, recent Commission amendments to
investment adviser rules are ``designed to provide additional
safeguards . . . when a registered adviser has custody of client funds
or securities'' including a requirement to undergo an annual surprise
examination by an independent public accountant to verify client assets
and a requirement to have a report of the internal controls relating to
the custody of client assets from an accountant registered with, and
subject to inspection by, the PCAOB unless client assets are maintained
by an independent custodian.\868\ Consequently, the regulations
governing

investment advisers have been strengthened in recent years through new
requirements aimed at safeguarding customer assets. Today's amendments
also are aimed at safeguarding customer assets. As both investment
advisers and broker-dealers are now subject to new requirements,
today's amendments should not create a competitive advantage for either
class of registrant. Moreover, the recently adopted requirements for
investment advisers and the amendments adopted today are, among other
things, part of an effort to strengthen the Commission's rules
regarding the safekeeping of customer assets, in part in response to
several fraud cases brought by the Commission involving investment
advisers and broker-dealers.\869\
---------------------------------------------------------------------------

    \868\ See Custody of Funds or Securities of Clients by
Investment Advisers, 75 FR at 1456.
    \869\ Id.
---------------------------------------------------------------------------

    If the amendments increase investor confidence in broker-dealers,
they will promote capital formation. Moreover, for the reasons
discussed above, today's amendments should not unduly restrict
competition and should promote capital formation.\870\
---------------------------------------------------------------------------

    \870\ The Commission stated in the proposing release that its
preliminary view was that the proposed rule amendments promote
efficiency, competition, and capital formation and that any burden
on competition is justified by the benefits provided by the
amendments. See Broker-Dealer Reports, 76 FR at 37598.
---------------------------------------------------------------------------

    The amendments also should increase efficiencies. With respect to
the annual reporting amendments, updating the language of Rule 17a-5 to
replace outdated or inconsistent audit terminology is designed to
ensure that the requirements of the rule are better aligned with
applicable current audit standards. Further, the amendments facilitate
PCAOB oversight authority, including its ability to inspect audits of
broker-dealers, by providing that examinations or reviews of broker-
dealer annual reports be made in accordance with PCAOB standards. In
addition, the amendments strengthen and promote consistent compliance
with the financial responsibility rules for broker-dealers that
maintain custody of customer securities and funds by increasing the
focus of these broker-dealers and their independent public accountants
on compliance, and internal control over compliance, with the financial
responsibility rules. This, in turn, should help the Commission and the
broker-dealer's DEA identify broker-dealers that have weak internal
controls for safeguarding investor assets and improve the financial and
operational condition of broker-dealers and thereby provide more
protection for investor assets held by broker-dealers.
    The access to accountant amendments should increase efficiencies by
promoting more risk-based examinations by Commission and DEA staff. For
example, the examiners in some cases may be able to leverage the work
performed by the independent public accountants and, therefore, focus
on areas the accountants did not review. Similarly, the Form Custody
amendments should increase efficiencies by promoting more risk-based
examinations by Commission and DEA staff as they will be able to use
the profile of the broker-dealer's custody practices documented in Form
Custody to focus their reviews. For this reason, examinations may also
place fewer time demands on broker-dealer personnel.
    In significant part, the effect of these rules on efficiency and
capital formation are linked to the effect of these rules on
competition. For example, markets that are competitive and trusted may
be expected to promote the efficient allocation of capital. Similarly,
rules that promote, or do not unduly restrict, trust in broker-dealers
can be accompanied by regulatory benefits that minimize the risk of
market failure and thus promote efficiency within the market. Such
competitive markets would increase the efficiency by which market
participants could transact with broker-dealers.

VIII. Final Regulatory Flexibility Analysis

    The Regulatory Flexibility Act (``RFA'') \871\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. Section 603(a) \872\ of the Administrative Procedure
Act,\873\ as amended by the RFA, generally requires the Commission to
undertake a regulatory flexibility analysis of all proposed rules, or
proposed rule amendments, to determine the impact of such rulemaking on
small entities.\874\ Section 605(b) of the RFA provides that this
requirement does not apply to any proposed rule or proposed rule
amendment, which if adopted, would not ``have a significant economic
impact on a substantial number of small entities.'' \875\
---------------------------------------------------------------------------

    \871\ 5 U.S.C. 601 et seq.
    \872\ 5 U.S.C. 603(a).
    \873\ 5 U.S.C. 551 et seq.
    \874\ Although section 601(b) of the RFA defines the term small
entity, the statute permits agencies to formulate their own
definitions. The Commission has adopted definitions for the term
``small entity'' for the purposes of Commission rulemaking in
accordance with the RFA. Those definitions, as relevant to this
rulemaking, are set forth in Rule 0-10. See 17 CFR 240.0-10. See
Statement of Management on Internal Accounting Control, Exchange Act
Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982).
    \875\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    The Commission proposed amendments to Rules 17a-5 and 17a-11 and
proposed new Form Custody. An Initial Regulatory Flexibility Analysis
(``IRFA'') was included in the proposing release.\876\ This Final
Regulatory Flexibility Analysis has been prepared in accordance with
the provisions of the RFA.
---------------------------------------------------------------------------

    \876\ See Broker-Dealer Reports, 76 FR at 37601-37602.
---------------------------------------------------------------------------

A. Need for and Objectives of the Amendments and New Form

    The final rules amend certain broker-dealer annual reporting,
audit, and notification requirements. The amendments include a
requirement that broker-dealer audits be conducted in accordance with
standards of the PCAOB, that broker-dealers file either a compliance
report or an exemption report covered by a report prepared by an
independent public accountant, and that clearing broker-dealers allow
representatives of the Commission or the broker-dealer's DEA to review
the documentation associated with certain reports of the broker-
dealer's independent public accountant and to allow the accountant to
discuss its findings with the representatives when requested in
connection with a regulatory examination of the broker-dealer. The
amendments also require a broker-dealer to file a new form with its DEA
that elicits information about the broker-dealer's practices with
respect to the custody of securities and funds of customers and others.
    The amendments and new form are designed, among other things, to
provide additional safeguards with respect to broker-dealer custody of
customer securities and funds, to enhance the ability of the Commission
to oversee broker-dealer custody practices, to increase the focus of
carrying broker-dealers and their independent public accountants on
compliance, and internal control over compliance, with certain
financial and custodial requirements, to facilitate the ability of the
PCAOB to implement the explicit oversight authority over broker-dealer
audits provided to the PCAOB by the Dodd-Frank Act, and to satisfy the
internal control report requirement in Rule 206(4)-2 for certain
broker-dealers affiliated with, or dually-registered as, investment
advisers.

B. Significant Issues Raised by Public Comments

    The Commission requested comment with regard to matters discussed
in the IRFA, including comments with respect to the number of small
entities that may be affected by the proposed rule amendments and
whether the effect on small entities would be economically
significant.\877\
---------------------------------------------------------------------------

    \877\ Id. at 37602.
---------------------------------------------------------------------------

    The Commission did not receive any comments specifically addressing
the IRFA. However, several commenters discussed the impact of the
proposal on small broker-dealers. One commenter stated that the
proposed amendments ``place unnecessary regulatory burdens and costs on
the industry, in general, and smaller firms in particular.'' \878\
Another commenter stated that small broker-dealers may find the timing
of the transition to be a ``burden,'' and requested that the Commission
provide a longer transition period.\879\ A third commenter suggested
that the exemption report and the accountant's report on the exemption
report be replaced with a ``check box on the FOCUS report'' and that
with regard to these reports ``[t]he amount of paperwork involved for
small firms that do not carry customer securities seems rather
excessive.'' \880\ A fourth commenter stated that the proposed
transition period may burden smaller broker-dealers, and suggested that
to facilitate the transition, the Commission should provide examples of
best practices and deficiencies, with the cooperation of the
AICPA.\881\ This commenter also suggested that the effective date for
the annual reporting requirements should be one year after publication
of the final rule.\882\
---------------------------------------------------------------------------

    \878\ See IMS Letter.
    \879\ See Citrin Letter.
    \880\ See Angel Letter.
    \881\ See Citrin Letter.
    \882\ Id. The commenter also specifically suggested that if non-
carrying and smaller broker-dealers must use PCAOB standards, that
the Commission should defer the effective date for one year after
the approval of the amendments. Id.
---------------------------------------------------------------------------

    The Commission is sensitive to the burdens the rule amendments and
new form will have on small broker-dealers. To remove unnecessary
burdens, the final rule amendments contain certain modifications from
the proposal designed to alleviate some of the concerns regarding small
broker-dealers.\883\ The modifications are discussed in the following
paragraphs.
---------------------------------------------------------------------------

    \883\ As is discussed below, small broker-dealers are in most
instances not carrying broker-dealers. See section VIII.C. of this
release.
---------------------------------------------------------------------------

    As is discussed above, the Commission has modified the proposed
amendments with respect to the exemption report in a manner that will
likely result in lower costs for small broker-dealers than would have
been the case if the Commission had adopted the proposed amendments
without the modifications. In particular, the final rule provides that
a broker-dealer can file the exemption report if it ``claimed that it
was exempt'' from Rule 15c3-3 throughout the most recent fiscal year.
This modification from the proposal--which provided that a broker-
dealer could file the exemption report if the broker-dealer ``is exempt
from Rule 15c3-3''--is designed to address concerns raised by
commenters that a non-carrying broker-dealer might be required to file
the compliance report because of an instance during the year in which
it did not meet the relied on exemption provision in paragraph (k) of
Rule 15c3-3.\884\ As discussed in the economic analysis, the compliance
report costs are significantly greater than the exemption report costs.
The final rule clarifies that a non-carrying broker-dealer that has an
exception to meeting the exemption provisions in paragraph (k) of Rule
15c3-3 need not file the compliance report; however, the broker-dealer
would be required to identify, to its best knowledge and belief, in its
exemption report each exception during the most recent fiscal year, if
applicable, including a brief description of the exception and the
approximate date on which the exception existed.
---------------------------------------------------------------------------

    \884\ See SIFMA Letter. As discussed above in section II.B.1. of
this release, there will be cases where a broker-dealer changes its
business model to convert from a carrying broker-dealer to a non-
carrying broker-dealer during the fiscal year. In this case, the
broker-dealer could seek exemptive relief under section 36 of the
Exchange Act (15 U.S.C. 78mm) from the requirement to file the
compliance report and to instead file the exemption report. In
analyzing such a request, the period of time the broker-dealer
operated as a carrying broker-dealer would be a relevant
consideration.
---------------------------------------------------------------------------

    In addition, only clearing broker-dealers will be subject to the
requirements that the Commission is adopting today that provide
Commission and DEA examination staff with the ability to review audit
documentation associated with broker-dealers' annual audit reports and
allow their independent public accountants to discuss findings relating
to the audit reports with Commission and DEA examination staff.
    To alleviate burdens associated with Form Custody, the Commission
has modified the form's instructions to make clear that questions on
the form that cannot be answered because the broker-dealer does not
engage in a particular activity do not need to be answered.
    In response to comments, the Commission also has delayed the
effective dates associated with the proposed reporting and attestation
amendments, which will provide all broker-dealers, including smaller
broker-dealers, with a longer transition period to prepare for the new
requirements.
    As is discussed above, the Commission considered the comment that
it should replace the exemption report with a box to check on the FOCUS
Report as the amount of paperwork for small firms ``seems rather
excessive.'' \885\ After careful consideration of this and other
alternatives, the Commission determined that of the alternatives
considered, none are appropriate alternatives to the exemption report.
Requiring the broker-dealer to (1) create a separate written report
stating that it is claiming the exemption and identifying the basis for
the exemption, including any identified exceptions in meeting the
conditions set forth in Sec.  240.15c3-3(k) and (2) file this report
with the Commission and the broker-dealer's DEA should increase broker-
dealers' focus on the accuracy of its compliance with the statements
being made because of the potential for liability for false statements,
enhance compliance with the exemption conditions in Rule 15c3-3, and
therefore provide better protection of customer assets.
---------------------------------------------------------------------------

    \885\ See section II.B.4.iii. of this release.
---------------------------------------------------------------------------

    Finally, with respect to the comment that the Commission should
provide examples of best practices and deficiencies with the
cooperation of the AICPA, the Commission notes that the question of
whether further guidance is necessary is best answered after the
requirements become effective and practical compliance questions arise.
In addition, the Commission will publish a Small Entity Compliance
Guide relating to these amendments.

C. Small Entities Subject to the Rules

    Paragraph (c) of Rule 0-10 provides that, for purposes of the RFA,
a small entity when used with reference to a broker-dealer (``small
broker-dealer'') means a broker-dealer that: (1) Had total capital (net
worth plus subordinated liabilities) of less than $500,000 on the date
in the prior fiscal year as of which its audited financial statements
were prepared pursuant to Rule 17a-5(d) or, if not required to file
such statements, a broker-dealer that had total capital (net worth plus
subordinated liabilities)

of less than $500,000 on the last business day of the preceding fiscal
year (or in the time that it has been in business if shorter); and (2)
is not affiliated with any person (other than a natural person) that is
not a small business or small organization.\886\ Based on December 31,
2011 FOCUS Report data, the Commission estimates that there are
approximately 812 broker-dealers that are classified as ``small''
entities for purposes of the RFA. Of these, the Commission estimates
that there are approximately eight broker-dealers that are carrying
broker-dealers. The Commission estimated for purposes of the IRFA that
there were approximately 871 broker-dealers that were classified as
small entities for purposes of the RFA and that there were no broker-
dealers that were carrying firms that satisfied the definition of a
small broker-dealer.\887\
---------------------------------------------------------------------------

    \886\ 17 CFR 240.0-10(c).
    \887\ See Broker-Dealer Reports, 76 FR at 37602. Although the
Commission received no comments regarding the its initial estimate
that there were no small carrying broker-dealers, the estimate is
nonetheless being revised based on additional analysis of available
information.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    The Commission's amendments to Rule 17a-5 retain the current
requirement that broker-dealers annually file financial statements and
supporting schedules (``financial report'') that must be audited by a
PCAOB-registered accountant. Under the amendments, the financial report
must be audited in accordance with standards of the PCAOB, instead of
in accordance with GAAS, as previously required.
    In addition to the financial report, the amendments require broker-
dealers to file one of two new reports: either a compliance report or
an exemption report. If a broker-dealer did not claim that it was
exempt from Rule 15c3-3 throughout the most recent fiscal year, the
broker-dealer must prepare and file with the Commission a compliance
report containing certain statements regarding the broker-dealer's
internal control over compliance with the financial responsibility
rules and compliance with certain of those rules. Alternatively, if the
broker-dealer claimed that it was exempt from Rule 15c3-3 throughout
the most recent fiscal year, the broker-dealer must prepare and file
with the Commission an exemption report containing a statement that it
claimed that it was exempt from Rule 15c3-3 during that period and
identify the provisions under which it claimed that it was exempt from
Rule 15c3-3.
    The amendments to Rule 17a-5 also eliminate the ``material
inadequacy'' concept and, among other things, replace the requirement
that the broker-dealer's independent public accountant prepare, and the
broker-dealer file with the Commission, a material inadequacy report
with a requirement for the accountant to prepare a new report covering
either the compliance report or the exemption report, as applicable. If
the broker-dealer is a carrying broker-dealer, the accountant must
prepare a report based on an examination, in accordance with PCAOB
standards, of certain statements by the broker-dealer in the compliance
report. If the broker-dealer claimed an exemption from Rule 15c3-3, the
accountant must prepare a report based on a review, in accordance with
PCAOB standards, of the exemption report. Broker-dealers must file
these reports of the accountant with the Commission along with the
financial report and either the compliance report or the exemption
report.
    Together, the financial report and the compliance report or the
exemption report and the accountant's reports covering those reports
comprise the annual reports that the broker-dealer must file each
fiscal year with the Commission and the broker-dealer's DEA. The
amendments require that the broker-dealer also file the annual reports
with SIPC if the broker-dealer is a member of SIPC.
    Amendments to Rule 17a-5 also require that if, during the course of
an audit, a broker-dealer's independent public accountant determines
that the broker-dealer is not in compliance with the financial
responsibility rules, or that any material weaknesses exist, the
accountant must immediately notify the broker-dealer. The broker-dealer
must notify the Commission and its DEA of the material weakness and
must notify the Commission and the DEA of the non-compliance if that
non-compliance would otherwise trigger a notification requirement.
    Amendments to Rule 17a-11 require that when a broker-dealer
discovers, or is notified by its independent public accountant, of the
existence of any material weakness under Rule 17a-5, the broker-dealer
must notify the Commission and transmit a report to the Commission
stating what the broker-dealer has done or is doing to correct the
situation. The amendments substituted the term material weakness for
the term material inadequacy with regard to Rule 17a-5.
    Under the amendments, carrying broker-dealers or those that clear
transactions must agree to allow Commission or DEA examination staff,
if requested in writing for purposes of an examination of the broker-
dealer, to review ``the documentation associated with the reports of
the accountant'' and to discuss the accountant's findings with the
accountant.
    The amendments require broker-dealers to file a new ``Form
Custody'' each quarter to elicit information concerning whether a
broker-dealer maintains custody of customer and non-customer assets,
and, if so, how such assets are maintained. Form Custody must be filed
with the broker-dealer's DEA. The DEA must transmit the information
obtained from Form Custody to the Commission at the same time that it
transmits FOCUS Report data to the Commission under paragraph (a)(4) of
Rule 17a-5.
    The impact of the amendments on small broker-dealers will be
substantially less than on larger firms. Most small broker-dealers are
exempt from Rule 15c3-3 and therefore must file the exemption report.
As discussed above, the exemption report must be reviewed by the
independent public accountant, in lieu of the compliance report, which
must be examined by the accountant. In addition, Form Custody would
elicit less information from broker-dealers that do not maintain
custody of customer assets, and therefore the form should be less
burdensome for these broker-dealers.

E. Agency Action To Minimize Effect on Small Entities

    Pursuant to section 3(a) of the RFA,\888\ the Commission must
consider significant alternatives that would accomplish the
Commission's stated objectives, while minimizing any significant
adverse impact on small entities. In connection with the final rules,
the Commission considered the following alternatives: (1) Establishing
differing compliance or reporting requirements or timetables that take
into account the resources available to smaller entities; (2)
clarifying, consolidating, or simplifying compliance and reporting
requirements for smaller entities; (3) the use of performance standards
rather than design standards; and (4) exempting smaller entities from
coverage of the rules, or any part of the rules.
---------------------------------------------------------------------------

    \888\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    The Commission considered differing compliance and reporting
requirements and timetables in adopting the amendments discussed in
this release, which took into account the resources available to
smaller entities. For

example, as is discussed above, the Commission considered alternatives
to the exemption report requirements, which resulted in modifications
to the final rule that make clear that broker-dealers claiming
exemptions from Rule 15c3-3 will remain subject to those requirements
even if certain exceptions arise.\889\ This reduces the burden on small
broker-dealers that would otherwise be subject to the more resource-
intensive compliance and examination report requirements applicable to
carrying broker-dealers.
---------------------------------------------------------------------------

    \889\ See sections II.B.4.iii. and VII.C.1.ii.b. of this
release.
---------------------------------------------------------------------------

    In addition, the Commission, in establishing effective dates for
these amendments, considered the resources available to small broker-
dealers. In this regard, the Commission is delaying the effective dates
for the audit and reporting requirements, which will provide small
broker-dealers with greater flexibility in allocating their resources
while preparing to comply with applicable amendments.
    The Commission also clarified, consolidated, and simplified
compliance and reporting requirements for broker-dealers in connection
with the amendments. As discussed above, the Commission clarified and
simplified requirements applicable to Form Custody by specifying in the
final form that broker-dealers are not required to answer questions
that do not apply to their business activities. Further, in terms of
consolidating regulatory requirements applicable to broker-dealers, a
broker-dealer affiliated with, or dually-registered as, an investment
adviser that is subject to the compliance report requirement can use
the independent public accountant's examination of the compliance
report to satisfy reporting obligations under Advisers Act Rule 206(4)-
2.
    The Commission generally used design standards rather than
performance standards in connection with the final rule amendments
because the Commission believes design standards will better accomplish
its objectives of enhancing safeguards with respect to broker-dealer
custody of securities and funds. The specific disclosure requirements
in the final rule will promote comparable and consistent types of
disclosures by broker-dealers, which will facilitate the ability of
Commission and DEA staff to assess broker-dealer compliance with
applicable requirements.
    The Commission also considered, and is adopting, amendments that
exempt certain types of broker-dealers from certain requirements. For
example, broker-dealers that are not clearing broker-dealers, which
include most small broker-dealers, do not need to comply with the
access to accountant and audit documentation amendments. Most small
broker-dealers also will not be subject to the new compliance and
examination report requirements, as small broker-dealers are in most
instances not carrying broker-dealers.
    In addition, if the Commission subsequently determines that it is
appropriate to exempt a broker-dealer, or type of broker-dealer, from
such requirements, the Commission has existing authority under which it
can act. In particular, under Exchange Act section 36, the Commission,
by rule, regulation, or order, may exempt any person, or any class or
classes of persons, from any rule under the Exchange Act to the extent
that such exemption is necessary or appropriate in the public interest
and is consistent with the protection of investors.\890\
---------------------------------------------------------------------------

    \890\ 15 U.S.C. 78mm.
---------------------------------------------------------------------------

IX. Statutory Authority

    The Commission is amending Rule 17a-5 and Rule 17a-11 under the
Exchange Act (17 CFR 240.17a-5 and 17 CFR 240.17a-11) and adopting new
Form Custody (17 CFR 249.639) pursuant to the authority conferred by
the Exchange Act, including sections 15, 17, 23(a) and 36.\891\
---------------------------------------------------------------------------

    \891\ 15 U.S.C. 78o, 78q, 78w(a) and 78mm.
---------------------------------------------------------------------------

List of Subjects in 17 CFR Parts 240 and 249

    Brokers, Confidential business information, Fraud, Reporting and
recordkeeping requirements, Securities.

Text of the Amendments

    For the reasons set out in the preamble, the Commission is amending
Title 17, Chapter II, of the Code of Federal Regulations as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934

0
1. The authority citation for part 240 continues to read, in part, as
follows:

    Authority:  15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq., and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Pub. L. 111-203, 939A, 124 Stat. 1376, (2010), unless otherwise
noted.
* * * * *

0
2. Section 240.17a-5 is amended by:
0
a. In paragraph (a)(2)(i), adding the word ``transactions'' after the
word ``clears'' and removing the words ``shall file'' and adding in
their place ``must file with the Commission.''
0
b. In paragraph (a)(2)(ii), removing the words ``shall file'' and
adding in their place ``must file with the Commission'' and removing
the phrase ``date selected for the annual audit of financial statements
where said date is other than a calendar quarter'' and adding in its
place ``end of the fiscal year of the broker or dealer where that date
is not the end of a calendar quarter.'';
0
c. In paragraph (a)(2)(iii), removing the phrase ``who does not carry
nor clear transactions nor carry customer accounts shall file'' and
adding in its place ``that neither clears transactions nor carries
customer accounts must file with the Commission'' and removing the
phrase ``date selected for the annual audit of financial statements
where said date is other than the end of the calendar quarter.'' and
adding in its place ``end of the fiscal year of the broker or dealer
where that date is not the end of a calendar quarter.'';
0
d. In paragraph (a)(2)(iv), removing the words ``shall file'' and
adding in their place ``must file with the Commission'' and adding the
phrase ``(``designated examining authority'')'' after the phrase
``section 17(d) of the Act'';
0
e. In paragraph (a)(3), in the first sentence, adding the words ``that
must be filed with the Commission'' after the words ``provided for in
this paragraph (a)'';
0
f. Redesignating paragraphs (a)(5) and (6) as paragraphs (a)(6) and
(7);
0
g. In newly redesignated paragraph (a)(6)(ii)(A), removing the phrase
``(a)(5)(i)'' and adding in its place ``(a)(6)(i)'';
0
h. Adding new paragraph (a)(5);
0
i. Revising paragraph (b)(2);
0
j. In paragraph (b)(4), removing the word ``he'' and adding in its
place ``the broker or dealer''.
0
k. Removing paragraph (b)(6);
0
l. In paragraph (c)(1)(i), removing the phrase ``his customers'' and
adding in its place ``customers of the introducing broker or dealer'';
0
m. In paragraph (c)(1)(iii), removing the phrase ``in the manner
contemplated by the $2,500 minimum net capital requirement of Sec.
240.15c3-1'' and adding in its place ``and otherwise qualified to
maintain net capital of no less than what is required under Sec.
240.15c3-1(a)(2)(iv)'';
0
n. In paragraph (c)(2) introductory text, in the first sentence,
removing the phrase ``date of the audited financial statements required
by paragraph (d) of

this section'' and adding in its place ``end of the fiscal year of the
broker or dealer'';
0
o. In paragraph (c)(2)(i) removing the phrase ``balance sheet with
appropriate notes prepared in accordance with'' and adding in its place
``Statement of Financial Condition with appropriate notes prepared in
accordance with U.S.'';
0
p. Removing paragraph (c)(2)(iii);
0
q. Redesignating paragraph (c)(2)(iv) as (c)(2)(iii);
0
r. In newly redesignated paragraph (c)(2)(iii), removing the phrase
``annual audit report of the broker or dealer pursuant to Sec.
240.17a-5'' and adding in its place ``financial report of the broker or
dealer under paragraph (d)(1)(i)(A) of this section'' and adding at the
end the word ``and'';
0
s. Adding new paragraph (c)(2)(iv);
0
t. In paragraph (c)(4) introductory text removing the word
```customer''' and adding in its place ``customer'';
0
u. In paragraphs (c)(5)(ii)(A) and (c)(5)(iii) introductory text,
removing the phrases ``Web site'' and ``Web sites'' and adding in their
place ``website'' and ``websites'';
0
v. Removing paragraph (c)(5)(vi);
0
w. Revising paragraph (d);
0
x. In paragraph (e) introductory text, removing the phrase ``financial
statements'' and adding in its place ``annual reports'' and removing
the word ``shall'' and adding in its place ``must'';
0
y. Revising paragraphs (e)(1) through (4);
0
z. Removing paragraph (e)(5);
0
aa. Revising paragraphs (f) through (i);
0
bb. Removing and reserving paragraph (j);
0
cc. In paragraph (m)(1), removing the word ``audit'' after the word
``annual''; and
0
dd. In paragraph (n)(2) removing the phrase ``audit report'' and adding
in its place ``annual reports''; adding the phrase ``in writing'' after
the word ``approved'' and removing the phrase ``pursuant to paragraph
(d)(1)(i) of this section'' and adding in its place ``of the broker or
dealer''.
    The revisions and additions read as follows:

Sec.  240.17a-5  Reports to be made by certain brokers and dealers.

    (a) * * *
    (5) Every broker or dealer subject to this paragraph (a) must file
Form Custody (Sec.  249.639 of this chapter) with its designated
examining authority within 17 business days after the end of each
calendar quarter and within 17 business days after the end of the
fiscal year of the broker or dealer where that date is not the end of a
calendar quarter. The designated examining authority must maintain the
information obtained through the filing of Form Custody and transmit
the information to the Commission, at such time as it transmits the
applicable part of Form X-17A-5 (Sec.  249.617 of this chapter) as
required in paragraph (a)(4) of this section.
* * * * *
    (b) * * *
    (2) The broker or dealer must attach to the report required by
paragraph (b)(1) of this section an oath or affirmation that to the
best knowledge and belief of the person making the oath or affirmation
the information contained in the report is true and correct. The oath
or affirmation must be made before a person duly authorized to
administer such oaths or affirmations. If the broker or dealer is a
sole proprietorship, the oath or affirmation must be made by the
proprietor; if a partnership, by a general partner; if a corporation,
by a duly authorized officer; or if a limited liability company or
limited liability partnership, by the chief executive officer, chief
financial officer, manager, managing member, or those members vested
with management authority for the limited liability company or limited
liability partnership.
* * * * *
    (c) * * *
    (2) * * *
    (iv) If, in connection with the most recent annual reports required
under paragraph (d) of this section, the report of the independent
public accountant required under paragraph (d)(1)(i)(C) of this section
covering the report of the broker or dealer required under paragraph
(d)(1)(i)(B)(1) of this section identifies one or more material
weaknesses, a statement by the broker or dealer that one or more
material weaknesses have been identified and that a copy of the report
of the independent public accountant required under paragraph
(d)(1)(i)(C) of this section is currently available for the customer's
inspection at the principal office of the Commission in Washington, DC,
and the regional office of the Commission for the region in which the
broker or dealer has its principal place of business.
* * * * *
    (d) Annual reports. (1)(i) Except as provided in paragraphs
(d)(1)(iii) and (d)(1)(iv) of this section, every broker or dealer
registered under section 15 of the Act must file annually:
    (A) A financial report as described in paragraph (d)(2) of this
section; and
    (B)(1) If the broker or dealer did not claim it was exempt from
Sec.  240.15c3-3 throughout the most recent fiscal year, a compliance
report as described in paragraph (d)(3) of this section executed by the
person who makes the oath or affirmation under paragraph (e)(2) of this
section; or
    (2) If the broker or dealer did claim that it was exempt from Sec.
240.15c3-3 throughout the most recent fiscal year, an exemption report
as described in paragraph (d)(4) of this section executed by the person
who makes the oath or affirmation under paragraph (e)(2) of this
section;
    (C) Except as provided in paragraph (e)(1)(i) of this section, a
report prepared by an independent public accountant, under the
engagement provisions in paragraph (g) of this section, covering each
report required to be filed under paragraphs (d)(1)(i)(A) and (B) of
this section.
    (ii) The reports required to be filed under this paragraph (d) must
be as of the same fiscal year end each year, unless a change is
approved in writing by the designated examining authority for the
broker or dealer under paragraph (n) of this section. A copy of the
written approval must be sent to the Commission's principal office in
Washington, DC, and the regional office of the Commission for the
region in which the broker or dealer has its principal place of
business.
    (iii) A broker or dealer succeeding to and continuing the business
of another broker or dealer need not file the reports under this
paragraph (d) as of a date in the fiscal year in which the succession
occurs if the predecessor broker or dealer has filed reports in
compliance with this paragraph (d) as of a date in such fiscal year.
    (iv) A broker or dealer that is a member of a national securities
exchange, has transacted a business in securities solely with or for
other members of a national securities exchange, and has not carried
any margin account, credit balance, or security for any person who is
defined as a customer in paragraph (c)(4) of this section, is not
required to file reports under this paragraph (d).
    (2) Financial report. The financial report must contain:
    (i) A Statement of Financial Condition, a Statement of Income, a
Statement of Cash Flows, a Statement of Changes in Stockholders' or
Partners' or Sole Proprietor's Equity, and a Statement of Changes in
Liabilities Subordinated to Claims of General Creditors. The statements
must be prepared in accordance with U.S. generally accepted accounting
principles and must be in a format that is consistent with the
statements

contained in Form X-17A-5 (Sec.  249.617 of this chapter) Part II or
Part IIA. If the Statement of Financial Condition filed in accordance
with instructions to Form X-17A-5, Part II or Part IIA, is not
consolidated, a summary of financial data, including the assets,
liabilities, and net worth or stockholders' equity, for subsidiaries
not consolidated in the Part II or Part IIA Statement of Financial
Condition as filed by the broker or dealer must be included in the
notes to the financial statements reported on by the independent public
accountant.
    (ii) Supporting schedules that include, from Part II or Part IIA of
Form X-17A-5 (Sec.  249.617 of this chapter), a Computation of Net
Capital Under Sec.  240.15c3-1, a Computation for Determination of the
Reserve Requirements under Exhibit A of Sec.  240.15c3-3, and
Information Relating to the Possession or Control Requirements Under
Sec.  240.15c3-3.
    (iii) If either the Computation of Net Capital under Sec.
240.15c3-1 or the Computation for Determination of the Reserve
Requirements Under Exhibit A of Sec.  240.15c3-3 in the financial
report is materially different from the corresponding computation in
the most recent Part II or Part IIA of Form X-17A-5 (Sec.  249.617 of
this chapter) filed by the broker or dealer pursuant to paragraph (a)
of this section, a reconciliation, including appropriate explanations,
between the computation in the financial report and the computation in
the most recent Part II or Part IIA of Form X-17A-5 filed by the broker
or dealer. If no material differences exist, a statement so indicating
must be included in the financial report.
    (3) Compliance report. (i) The compliance report must contain:
    (A) Statements as to whether:
    (1) The broker or dealer has established and maintained Internal
Control Over Compliance as that term is defined in paragraph (d)(3)(ii)
of this section;
    (2) The Internal Control Over Compliance of the broker or dealer
was effective during the most recent fiscal year;
    (3) The Internal Control Over Compliance of the broker or dealer
was effective as of the end of the most recent fiscal year;
    (4) The broker or dealer was in compliance with Sec. Sec.
240.15c3-1 and 240.15c3-3(e) as of the end of the most recent fiscal
year; and
    (5) The information the broker or dealer used to state whether it
was in compliance with Sec. Sec.  240.15c3-1 and 240.15c3-3(e) was
derived from the books and records of the broker or dealer.
    (B) If applicable, a description of each material weakness in the
Internal Control Over Compliance of the broker or dealer during the
most recent fiscal year.
    (C) If applicable, a description of any instance of non-compliance
with Sec. Sec.  240.15c3-1 or 240.15c3-3(e) as of the end of the most
recent fiscal year.
    (ii) The term Internal Control Over Compliance means internal
controls that have the objective of providing the broker or dealer with
reasonable assurance that non-compliance with Sec.  240.15c3-1, Sec.
240.15c3-3, Sec.  240.17a-13, or any rule of the designated examining
authority of the broker or dealer that requires account statements to
be sent to the customers of the broker or dealer (an ``Account
Statement Rule'') will be prevented or detected on a timely basis.
    (iii) The broker or dealer is not permitted to conclude that its
Internal Control Over Compliance was effective during the most recent
fiscal year if there were one or more material weaknesses in its
Internal Control Over Compliance during the most recent fiscal year.
The broker or dealer is not permitted to conclude that its Internal
Control Over Compliance was effective as of the end of the most recent
fiscal year if there were one or more material weaknesses in its
internal control as of the end of the most recent fiscal year. A
material weakness is a deficiency, or a combination of deficiencies, in
Internal Control Over Compliance such that there is a reasonable
possibility that non-compliance with Sec. Sec.  240.15c3-1 or 240.15c3-
3(e) will not be prevented or detected on a timely basis or that non-
compliance to a material extent with Sec.  240.15c3-3, except for
paragraph (e), Sec.  240.17a-13, or any Account Statement Rule will not
be prevented or detected on a timely basis. A deficiency in Internal
Control Over Compliance exists when the design or operation of a
control does not allow the management or employees of the broker or
dealer, in the normal course of performing their assigned functions, to
prevent or detect on a timely basis non-compliance with Sec.  240.15c3-
1, Sec.  240.15c3-3, Sec.  240.17a-13, or any Account Statement Rule.
    (4) Exemption report. The exemption report must contain the
following statements made to the best knowledge and belief of the
broker or dealer:
    (i) A statement that identifies the provisions in Sec.  240.15c3-
3(k) under which the broker or dealer claimed an exemption from Sec.
240.15c3-3;
    (ii) A statement that the broker or dealer met the identified
exemption provisions in Sec.  240.15c3-3(k) throughout the most recent
fiscal year without exception or that it met the identified exemption
provisions in Sec.  240.15c3-3(k) throughout the most recent fiscal
year except as described under paragraph (d)(4)(iii) of this section;
and
    (iii) If applicable, a statement that identifies each exception
during the most recent fiscal year in meeting the identified exemption
provisions in Sec.  240.15c3-3(k) and that briefly describes the nature
of each exception and the approximate date(s) on which the exception
existed.
    (5) The annual reports must be filed not more than sixty (60)
calendar days after the end of the fiscal year of the broker or dealer.
    (6) The annual reports must be filed at the regional office of the
Commission for the region in which the broker or dealer has its
principal place of business, the Commission's principal office in
Washington, DC, the principal office of the designated examining
authority for the broker or dealer, and with the Securities Investor
Protection Corporation (``SIPC'') if the broker or dealer is a member
of SIPC. Copies of the reports must be provided to all self-regulatory
organizations of which the broker or dealer is a member, unless the
self-regulatory organization by rule waives this requirement.
    (e) * * *
    (1)(i) The broker or dealer is not required to engage an
independent public accountant to provide the reports required under
paragraph (d)(1)(i)(C) of this section if, since the date of the
registration of the broker or dealer under section 15 of the Act (15
U.S.C. 78o) or of the previous annual reports filed under paragraph (d)
of this section:
    (A) The securities business of the broker or dealer has been
limited to acting as broker (agent) for the issuer in soliciting
subscriptions for securities of the issuer, the broker has promptly
transmitted to the issuer all funds and promptly delivered to the
subscriber all securities received in connection with the transaction,
and the broker has not otherwise held funds or securities for or owed
money or securities to customers; or
    (B) The securities business of the broker or dealer has been
limited to buying and selling evidences of indebtedness secured by
mortgage, deed of trust, or other lien upon real estate or leasehold
interests, and the broker or dealer has not carried any margin account,
credit balance, or security for any securities customer.
    (ii) A broker or dealer that files annual reports under paragraph
(d) of this

section that are not covered by reports prepared by an independent
public accountant must include in the oath or affirmation required by
paragraph (e)(2) of this section a statement of the facts and
circumstances relied upon as a basis for exemption from the requirement
that the annual reports filed under paragraph (d) of this section be
covered by reports prepared by an independent public accountant.
    (2) The broker or dealer must attach to the financial report an
oath or affirmation that, to the best knowledge and belief of the
person making the oath or affirmation,
    (i) The financial report is true and correct; and
    (ii) Neither the broker or dealer, nor any partner, officer,
director, or equivalent person, as the case may be, has any proprietary
interest in any account classified solely as that of a customer.
    The oath or affirmation must be made before a person duly
authorized to administer such oaths or affirmations. If the broker or
dealer is a sole proprietorship, the oath or affirmation must be made
by the proprietor; if a partnership, by a general partner; if a
corporation, by a duly authorized officer; or if a limited liability
company or limited liability partnership, by the chief executive
officer, chief financial officer, manager, managing member, or those
members vested with management authority for the limited liability
company or limited liability partnership.
* * * * *
    (3) The annual reports filed under paragraph (d) of this section
are not confidential, except that, if the Statement of Financial
Condition in a format that is consistent with Form X-17A-5 (Sec.
249.617 of this chapter), Part II, or Part IIA, is bound separately
from the balance of the annual reports filed under paragraph (d) of
this section, and each page of the balance of the annual reports is
stamped ``confidential,'' then the balance of the annual reports shall
be deemed confidential to the extent permitted by law. However, the
annual reports, including the confidential portions, will be available
for official use by any official or employee of the U.S. or any State,
by national securities exchanges and registered national securities
associations of which the broker or dealer filing such a report is a
member, by the Public Company Accounting Oversight Board, and by any
other person if the Commission authorizes disclosure of the annual
reports to that person as being in the public interest. Nothing
contained in this paragraph may be construed to be in derogation of the
rules of any registered national securities association or national
securities exchange that give to customers of a member broker or dealer
the right, upon request to the member broker or dealer, to obtain
information relative to its financial condition.
    (4)(i) The broker or dealer must file with SIPC a report on the
SIPC annual general assessment reconciliation or exclusion from
membership forms that contains such information and is in such format
as determined by SIPC by rule and approved by the Commission.
    (ii) Until the earlier of two years after the date paragraph
(e)(4)(i) of this section is effective or SIPC adopts a rule under
paragraph (e)(4)(i) of this section and the rule is approved by the
Commission, the broker or dealer must file with SIPC a supplemental
report on the status of the membership of the broker or dealer in SIPC
if, under paragraph (d)(1)(i)(C) of this section, the broker or dealer
is required to file reports prepared by an independent public
accountant. The supplemental report must include the independent public
accountant's report on applying agreed-upon procedures based on the
performance of the procedures enumerated in paragraph (e)(4)(ii)(C) of
this section. The supplemental report must cover the SIPC annual
general assessment reconciliation or exclusion from membership forms
not previously reported on under this paragraph (e)(4) that were
required to be filed on or prior to the date of the annual reports
required by paragraph (d) of this section: Provided, that the broker or
dealer is not required to file the supplemental report on the SIPC
annual general assessment reconciliation or exclusion from membership
form for any period during which the SIPC assessment is a specified
dollar value as provided for in section 4(d)(1)(c) of the Securities
Investor Protection Act of 1970, as amended. The supplemental report
must be filed with the regional office of the Commission for the region
in which the broker or dealer has its principal place of business, the
Commission's principal office in Washington, DC, the principal office
of the designated examining authority for the broker or dealer, and the
principal office of SIPC. The supplemental report must include the
following:
    (A) A schedule of assessment payments showing any overpayments
applied and overpayments carried forward including: payment dates,
amounts, and name of SIPC collection agent to whom mailed; or
    (B) If exclusion from membership was claimed, a statement that the
broker or dealer qualified for exclusion from membership under the
Securities Investor Protection Act of 1970, as amended; and
    (C) An independent public accountant's report. The independent
public accountant must be engaged to perform the following procedures:
    (1) Comparison of listed assessment payments with respective cash
disbursements record entries;
    (2) For all or any portion of a fiscal year, comparison of amounts
reflected in the annual reports required by paragraph (d) of this
section with amounts reported in the Annual General Assessment
Reconciliation (Form SIPC-7);
    (3) Comparison of adjustments reported in Form SIPC-7 with
supporting schedules and working papers supporting the adjustments;
    (4) Proof of the arithmetical accuracy of the calculations
reflected in Form SIPC-7 and in the schedules and working papers
supporting any adjustments; and
    (5) Comparison of the amount of any overpayment applied with the
Form SIPC-7 on which it was computed; or
    (6) If exclusion from membership is claimed, a comparison of the
income or loss reported in the financial report required by paragraph
(d)(2) of this section with the Certification of Exclusion from
Membership (Form SIPC-3).
    (f)(1) Qualifications of independent public accountant. The
independent public accountant must be qualified and independent in
accordance with Sec.  210.2-01 of this chapter and the independent
public accountant must be registered with the Public Company Accounting
Oversight Board if required by the Sarbanes-Oxley Act of 2002.
    (2) Statement regarding independent public accountant. (i) Every
broker or dealer that is required to file annual reports under
paragraph (d) of this section must file no later than December 10 of
each year (or 30 calendar days after the effective date of its
registration as a broker or dealer, if earlier) a statement as
prescribed in paragraph (f)(2)(ii) of this section with the
Commission's principal office in Washington, DC, the regional office of
the Commission for the region in which its principal place of business
is located, and the principal office of the designated examining
authority for the broker or dealer. The statement must be dated no
later than December 1 (or 20 calendar days after the effective date of
its registration as a broker or dealer, if earlier). If the engagement
of an

independent public accountant is of a continuing nature, providing for
successive engagements, no further filing is required. If the
engagement is for a single year, or if the most recent engagement has
been terminated or amended, a new statement must be filed by the
required date.
    (ii) The statement must be headed ``Statement regarding independent
public accountant under Rule 17a-5(f)(2)'' and must contain the
following information and representations:
    (A) Name, address, telephone number, and registration number of the
broker or dealer.
    (B) Name, address, and telephone number of the independent public
accountant.
    (C) The date of the fiscal year of the annual reports of the broker
or dealer covered by the engagement.
    (D) Whether the engagement is for a single year or is of a
continuing nature.
    (E) A representation that the independent public accountant has
undertaken the items enumerated in paragraphs (g)(1) and (2) of this
section.
    (F) Except as provided in paragraph (f)(2)(iii) of this section, a
representation that the broker or dealer agrees to allow
representatives of the Commission or its designated examining
authority, if requested in writing for purposes of an examination of
the broker or dealer, to review the audit documentation associated with
the reports of the independent public accountant filed under paragraph
(d)(1)(i)(C) of this section. For purposes of this paragraph, ``audit
documentation'' has the meaning provided in standards of the Public
Company Accounting Oversight Board. The Commission anticipates that, if
requested, it will accord confidential treatment to all documents it
may obtain from an independent public accountant under this paragraph
to the extent permitted by law.
    (G) Except as provided in paragraph (f)(2)(iii) of this section, a
representation that the broker or dealer agrees to allow the
independent public accountant to discuss with representatives of the
Commission and its designated examining authority, if requested in
writing for purposes of an examination of the broker or dealer, the
findings associated with the reports of the independent public
accountant filed under paragraph (d)(1)(i)(C) of this section.
    (iii) If a broker or dealer neither clears transactions nor carries
customer accounts, the broker or dealer is not required to include the
representations in paragraphs (f)(2)(ii)(F) and (G) of this section.
    (iv) Any broker or dealer that is not required to file reports
prepared by an independent public accountant under paragraph
(d)(1)(i)(C) of this section must file a statement required under
paragraph (f)(2)(i) of this section indicating the date as of which the
unaudited reports will be prepared.
    (3) Replacement of accountant. A broker or dealer must file a
notice that must be received by the Commission's principal office in
Washington, DC, the regional office of the Commission for the region in
which its principal place of business is located, and the principal
office of the designated examining authority for the broker or dealer
not more than 15 business days after:
    (i) The broker or dealer has notified the independent public
accountant that provided the reports the broker or dealer filed under
paragraph (d)(1)(i)(C) of this section for the most recent fiscal year
that the independent public accountant's services will not be used in
future engagements; or
    (ii) The broker or dealer has notified an independent public
accountant that was engaged to provide the reports required under
paragraph (d)(1)(i)(C) of this section that the engagement has been
terminated; or
    (iii) An independent public accountant has notified the broker or
dealer that the independent public accountant would not continue under
an engagement to provide the reports required under paragraph
(d)(1)(i)(C) of this section; or
    (iv) A new independent public accountant has been engaged to
provide the reports required under paragraph (d)(1)(i)(C) of this
section without any notice of termination having been given to or by
the previously engaged independent public accountant.
    (v) The notice must include:
    (A) The date of notification of the termination of the engagement
or of the engagement of the new independent public accountant, as
applicable; and
    (B) The details of any issues arising during the 24 months (or the
period of the engagement, if less than 24 months) preceding the
termination or new engagement relating to any matter of accounting
principles or practices, financial statement disclosure, auditing scope
or procedure, or compliance with applicable rules of the Commission,
which issues, if not resolved to the satisfaction of the former
independent public accountant, would have caused the independent public
accountant to make reference to them in the report of the independent
public accountant. The issues required to be reported include both
those resolved to the former independent public accountant's
satisfaction and those not resolved to the former accountant's
satisfaction. Issues contemplated by this section are those that occur
at the decision-making level--that is, between principal financial
officers of the broker or dealer and personnel of the accounting firm
responsible for rendering its report. The notice must also state
whether the accountant's report filed under paragraph (d)(1)(i)(C) of
this section for any of the past two fiscal years contained an adverse
opinion or a disclaimer of opinion or was qualified as to
uncertainties, audit scope, or accounting principles, and must describe
the nature of each such adverse opinion, disclaimer of opinion, or
qualification. The broker or dealer must also request the former
independent public accountant to furnish the broker or dealer with a
letter addressed to the Commission stating whether the independent
public accountant agrees with the statements contained in the notice of
the broker or dealer and, if not, stating the respects in which
independent public accountant does not agree. The broker or dealer must
file three copies of the notice and the accountant's letter, one copy
of which must be manually signed by the sole proprietor, a general
partner, or a duly authorized corporate, limited liability company, or
limited liability partnership officer or member, as appropriate, and by
the independent public accountant, respectively.
    (g) Engagement of independent public accountant. The independent
public accountant engaged by the broker or dealer to provide the
reports required under paragraph (d)(1)(i)(C) of this section must, as
part of the engagement, undertake the following, as applicable:
    (1) To prepare an independent public accountant's report based on
an examination of the financial report required to be filed by the
broker or dealer under paragraph (d)(1)(i)(A) of this section in
accordance with standards of the Public Company Accounting Oversight
Board; and
    (2)(i) To prepare an independent public accountant's report based
on an examination of the statements required under paragraphs
(d)(3)(i)(A)(2) through (5) of this section in the compliance report
required to be filed by the broker or dealer under paragraph
(d)(1)(i)(B)(1) of this section in accordance with standards of the
Public Company Accounting Oversight Board; or
    (ii) To prepare an independent public accountant's report based on
a review of the statements required under paragraphs (d)(4)(i) through
(iii) of this section in the exemption report required to be filed by
the broker or dealer under

paragraph (d)(1)(i)(B)(2) of this section in accordance with standards
of the Public Company Accounting Oversight Board.
    (h) Notification of non-compliance or material weakness. If, during
the course of preparing the independent public accountant's reports
required under paragraph (d)(1)(i)(C) of this section, the independent
public accountant determines that the broker or dealer is not in
compliance with Sec.  240.15c3-1, Sec.  240.15c3-3, or Sec.  240.17a-13
or any rule of the designated examining authority of the broker or
dealer that requires account statements to be sent to the customers of
the broker or dealer, as applicable, or the independent public
accountant determines that any material weaknesses (as defined in
paragraph (d)(3)(iii) of this section) exist, the independent public
accountant must immediately notify the chief financial officer of the
broker or dealer of the nature of the non-compliance or material
weakness. If the notice from the accountant concerns an instance of
non-compliance that would require a broker or dealer to provide a
notification under Sec.  240.15c3-1, Sec.  240.15c3-3, or Sec.
240.17a-11, or if the notice concerns a material weakness, the broker
or dealer must provide a notification in accordance with Sec.
240.15c3-1, Sec.  240.15c3-3, or Sec.  240.17a-11, as applicable, and
provide a copy of the notification to the independent public
accountant. If the independent public accountant does not receive the
notification within one business day, or if the independent public
accountant does not agree with the statements in the notification, then
the independent public accountant must notify the Commission and the
designated examining authority within one business day. The report from
the accountant must, if the broker or dealer failed to file a
notification, describe any instances of non-compliance that required a
notification under Sec.  240.15c3-1, Sec.  240.15c3-3, or Sec.
240.17a-11, or any material weaknesses. If the broker or dealer filed a
notification, the report from the accountant must detail the aspects of
the notification of the broker or dealer with which the accountant does
not agree.
    Note to paragraph (h): The attention of the broker or dealer and
the independent public accountant is called to the fact that under
Sec.  240.17a-11(b)(1), among other things, a broker or dealer whose
net capital declines below the minimum required pursuant to Sec.
240.15c3-1 shall give notice of such deficiency that same day in
accordance with Sec.  240.17a-11(g) and the notice shall specify the
broker or dealer's net capital requirement and its current amount of
net capital. The attention of the broker or dealer and accountant also
is called to the fact that under Sec.  240.15c3-3(i), if a broker or
dealer shall fail to make a reserve bank account or special account
deposit, as required by Sec.  240.15c3-3, the broker or dealer shall by
telegram immediately notify the Commission and the regulatory authority
for the broker or dealer, which examines such broker or dealer as to
financial responsibility and shall promptly thereafter confirm such
notification in writing.
    (i) Reports of the independent public accountant required under
paragraph (d)(1)(i)(C) of this section--(1) Technical requirements. The
independent public accountant's reports must:
    (i) Be dated;
    (ii) Be signed manually;
    (iii) Indicate the city and state where issued; and
    (iv) Identify without detailed enumeration the items covered by the
reports.
    (2) Representations. The independent public accountant's reports
must:
    (i) State whether the examinations or review, as applicable, were
made in accordance with standards of the Public Company Accounting
Oversight Board;
    (ii) Identify any examination and, if applicable, review procedures
deemed necessary by the independent public accountant under the
circumstances of the particular case that have been omitted and the
reason for their omission.
    (iii) Nothing in this section may be construed to imply authority
for the omission of any procedure that independent public accountants
would ordinarily employ in the course of an examination or review made
for the purpose of expressing the opinions or conclusions required
under this section.
    (3) Opinion or conclusion to be expressed. The independent public
accountant's reports must state clearly:
    (i) The opinion of the independent public accountant with respect
to the financial report required under paragraph (d)(1)(i)(A) of this
section and the accounting principles and practices reflected in that
report;
    (ii) The opinion of the independent public accountant with respect
to the financial report required under paragraph (d)(1)(i)(A) of this
section, as to the consistency of the application of the accounting
principles, or as to any changes in those principles, that have a
material effect on the financial statements; and
    (iii)(A) The opinion of the independent public accountant with
respect to the statements required under paragraphs (d)(3)(i)(A)(2)
through (5) of this section in the compliance report required under
paragraph (d)(1)(i)(B)(1) of this section; or
    (B) The conclusion of the independent public accountant with
respect to the statements required under paragraphs (d)(4)(i) through
(iii) of this section in the exemption report required under paragraph
(d)(1)(i)(B)(2) of this section.
    (4) Exceptions. Any matters to which the independent public
accountant takes exception must be clearly identified, the exceptions
must be specifically and clearly stated, and, to the extent
practicable, the effect of each such exception on any related items
contained in the annual reports required under paragraph (d) of this
section must be given.
* * * * *

0
3. Section 240.17a-11 is amended by:
0
a. Revising paragraph (e); and
0
b. In paragraph (h), removing the citation ``17a-5(h)(2)'' and adding
in its place the citation ``17a-5(h)'' and removing the citation ``17a-
12(f)(2)'' and adding in its place the citation ``17a-12(i)(2).''
    The revision reads as follows:

Sec.  240.17a-11  Notification provision for brokers and dealers.

* * * * *
    (e) Whenever any broker or dealer discovers, or is notified by an
independent public accountant under Sec.  240.17a-12(i)(2), of the
existence of any material inadequacy as defined in Sec.  240.17a-
12(h)(2), or whenever any broker or dealer discovers, or is notified by
an independent public accountant under Sec.  240.17a-5(h), of the
existence of any material weakness as defined in Sec.  240.17a-
5(d)(3)(iii), the broker or dealer must:
    (1) Give notice, in accordance with paragraph (g) of this section,
of the material inadequacy or material weakness within 24 hours of the
discovery or notification of the material inadequacy or the material
weakness; and
    (2) Transmit a report, in accordance with paragraph (g) of this
section, within 48 hours of the notice stating what the broker or
dealer has done or is doing to correct the situation.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

0
4. The authority citation for part 249 continues to read, in part, as
follows:

    Authority:  15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C.
5461 et seq.; and 18 U.S.C. 1350, unless otherwise noted.
* * * * *

Subpart G--Forms for Reports To Be Made by Certain Exchange
Members, Brokers, and Dealers

0
5. Add Form Custody (referenced in Sec.  249.639) to subpart G to read
as follows:

Sec.  249.639  Form custody.

    This form shall be used for reports of information required by
Sec.  240.17a-5 of this chapter.

    Note: The text of Form Custody will not appear in the Code of
Federal Regulations.

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    By the Commission.

     Dated: July 30, 2013.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013-18738 Filed 8-20-13; 8:45 am]
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