a bank, and by other customers to sweep their free credit balances to a
U.S. money market fund). The Commission did not receive any comments on
Items 3.D.iii and 3.E.iii of proposed Form Custody and is adopting
these Items as proposed.
---------------------------------------------------------------------------

    \593\ Id.
---------------------------------------------------------------------------

    A broker-dealer will be required to check the box in the first
column of the chart for every process that applies to the broker-
dealer's treatment of free credit balances in customer and non-customer
accounts, respectively. The first process identified on each chart is
that the broker-dealer treats customer and non-customer free credit
balances in accordance with the customer reserve computation required
under paragraph (e) of Rule 15c3-3. Paragraph (e) of Rule 15c3-3
requires a broker-dealer to maintain a special reserve bank account for
the exclusive benefit of its customers and maintain deposits in that
account (to the extent a deposit is required) in amounts computed in
accordance with Exhibit A to Rule 15c3-3.\594\ Rule 15c3-3 requires
that a broker-dealer comply with these reserve account provisions only
with respect to customer-related credit balances. The Commission has,
however, proposed amendments to Rule 15c3-3 that would require a
broker-dealer to maintain a reserve account and perform a reserve
computation for non-customer accountholders that are domestic and
foreign broker-dealers.\595\
---------------------------------------------------------------------------

    \594\ See Rule 15c3-3(e) and Rule 15c3-3a.
    \595\ See Amendments to Financial Responsibility Rules for
Broker-Dealers, Exchange Act Release No. 55431 (Mar. 9, 2007), 72 FR
12862 (Mar. 19, 2007); Amendments to Financial Responsibility Rules
for Broker-Dealers (Reopening of Comment Period), Exchange Act
Release No. 34-66910 (May 3, 2012), 77 FR 27150 (May 9, 2012). See
also letter from Michael A. Macchiaroli, Associate Director,
Division of Market Regulation, Commission, to Raymond J. Hennessy,
Vice President, New York Stock Exchange (``NYSE''), and Thomas
Cassella, Vice President, NASD Regulation, Inc. (Nov. 10, 1998).
---------------------------------------------------------------------------

    The second process identified on the chart is that the broker-
dealer handles free credit balances by placing funds in a ``bank
account under Rule 15c3-3(k)(2)(i).'' Paragraph (k)(2)(i) of Rule 15c3-
3 prescribes a process by which a broker-dealer can qualify for an
exemption from the requirements of Rule 15c3-3. Specifically, the
exemption applies to a broker-dealer that does not carry margin
accounts, promptly transmits all customer funds and delivers all
securities received in connection with its activities, does not
otherwise hold funds or securities for, or owe money or securities to,
customers and effectuates all financial transactions between the
broker-dealer and its customers through one or more bank accounts that
are each designated as a ``Special Account for the Exclusive Benefit of
Customers of (the name of broker or dealer).'' \596\
---------------------------------------------------------------------------

    \596\ See 17 CFR240.15c3-3(k)(2)(i).
---------------------------------------------------------------------------

    The third process identified in the chart--``swept to a U.S.
bank''--is included because some broker-dealers engage in ``bank sweep
programs.'' Rather than hold customer funds in securities accounts,
some broker-dealers require or offer the option to transfer free credit
balances in securities accounts to a specific money market fund or
interest bearing bank account (``Sweep Programs''). The customer earns
dividends on the money market fund or interest on the bank account
until such time as the customer chooses to liquidate the position in
order to use the cash, for example, to purchase securities.\597\
Customers must make a request to the broker-dealer for the return of
funds swept from their securities accounts to the bank.
---------------------------------------------------------------------------

    \597\ See Amendments to Financial Responsibility Rules for
Broker-Dealers, Exchange Act Release No. 55431 (Mar. 9, 2007), 72 FR
12862 (Mar. 19, 2007) at 12866.
---------------------------------------------------------------------------

    The fourth option identified in the chart is that the broker-dealer
sweeps free credit balances into a money market fund as part of a Sweep
Program. In most cases when a broker-dealer sweeps free credit balances
into a money market fund, the broker-dealer purchases shares in the
money market fund, which are registered in the name of the broker-
dealer. The money market fund understands that these shares are not
proprietary positions of the broker-dealer, and any interest earned on
the shares from the money market fund are payable to the customers.
    Finally, the fifth option in the chart covers any other process
that is not described in the other options.
4. Item 4--Carrying for Other Broker-Dealers
    Item 4 of proposed Form Custody would have required a broker-dealer
to disclose whether it acted as a carrying broker-dealer for other
broker-dealers.\598\ There were two sets of questions in Item 4--Item
4.A.i, ii, and iii and Item 4.B.i, ii, and iii. The first set of
questions would have elicited information from a broker-dealer as to
whether it carried transactions for other broker-dealers on a fully
disclosed basis.\599\ The second set of questions would have elicited
information from a broker-dealer as to whether it carried transactions
for other broker-dealers on an omnibus basis.\600\ The Commission did
not receive any comments to Item 4 of proposed Form Custody and is
adopting this Item as proposed.
---------------------------------------------------------------------------

    \598\ See Broker-Dealer Reports, 76 FR at 37589.
    \599\ Id.
    \600\ Id.
---------------------------------------------------------------------------

    Items 4.A.i and 4.B.i require a broker-dealer to indicate by
checking the appropriate ``Yes'' or ``No'' box whether it carries
customer accounts for another broker-dealer on a fully disclosed basis
and on an omnibus basis, respectively. Items 4.A.ii and 4.B.ii require
a broker-dealer, if applicable, to indicate the number of broker-
dealers with which it has an arrangement to carry accounts on a fully
disclosed basis and on an omnibus basis, respectively. Items 4.A.iii
and 4.B.iii require a broker-dealer, if applicable, to identify any
affiliated broker-dealers that introduce accounts to the broker-dealer
on a fully disclosed basis and on an omnibus basis, respectively.
    As the Commission has noted, related person custody arrangements
can present higher risks to ``advisory clients'' than maintaining
assets with an independent custodian.\601\ Consistent with the
definition of the term in other contexts applicable to broker-dealers,
including Form BD,\602\ the General

Instructions for Form Custody define the term ``affiliate'' as any
person who directly or indirectly controls the broker-dealer or any
person who is directly or indirectly controlled by or under common
control with the broker-dealer. The definition also specifies that
ownership of 25% or more of the common stock of the broker-dealer
introducing accounts to the broker-dealer submitting the Form Custody
is deemed prima facie evidence of control; this provision also is
consistent with the definition used in Form BD.\603\
---------------------------------------------------------------------------

    \601\ See Custody of Funds or Securities of Clients by
Investment Advisers, 75 FR at 1462.
    \602\ Form BD is the uniform application for broker-dealer
registration with the Commission. Form BD states that a person is
presumed to control a company if, among other things, that person
has directly or indirectly the right to vote 25% or more of a class
of a voting security or has the power to sell or direct the sale of
25% or more of a class of voting securities, or, in the case of a
partnership, the right to receive upon dissolution, or has
contributed, 25% or more of the firm's capital.
    \603\ This definition of the term affiliate is the same as the
definition in Form BD, including the specification that ownership of
25% or more of the common stock is deemed prima facie evidence of
control.
---------------------------------------------------------------------------

    Item 4 in Form Custody elicits information about broker-dealers'
custodial responsibilities with respect to accounts held for the
benefit of other broker-dealers, and requires broker-dealers to
identify such broker-dealers that are affiliates of the broker-
dealer.\604\ The Commission believes that this information will provide
the Commission with an enhanced understanding of, and useful and
readily available information relating to, the scope of broker-dealer
introducing/carrying relationships and activities, and the custodial
practices of broker-dealers involved in such relationships.
---------------------------------------------------------------------------

    \604\ Form Custody does not require a broker-dealer to identify
unaffiliated broker-dealers for which it carries accounts, though,
as discussed above, it would need to indicate that it carries
accounts for such broker-dealers. The Commission believes that this
approach provides the Commission and DEA examiners with access to
useful information involving a broker-dealer's custody practices
while alleviating potential time and cost burdens associated with
completing Form Custody given that some broker-dealers carry
accounts for hundreds of unaffiliated broker-dealers. The Commission
notes that information about these broker-dealers would be part of
the books and records of the carrying broker-dealer. Therefore, an
affirmative answer to Item 4 could prompt the Commission and DEA
examiners to request information about the identities of the
unaffiliated broker-dealers. See Broker-Dealer Reports, 76 FR at
37589 n.143.
---------------------------------------------------------------------------

5. Item 5--Trade Confirmations
    Item 5 of Form Custody, as proposed, would have required broker-
dealers to disclose whether they send transaction confirmations to
customers and other accountholders by checking the appropriate ``Yes''
or ``No'' box.\605\ Confirmations are important safeguards that enable
customers to monitor transactions that occur in their securities
accounts. Timely confirmations alert customers of unauthorized
transactions and provide customers with an opportunity to object to the
transactions. The Commission received one comment on Item 5 of proposed
Form Custody. As discussed below, the Commission is modifying the
instructions to Item 5 in response to this comment and is otherwise
adopting Item 5 as proposed.
---------------------------------------------------------------------------

    \605\ See Broker-Dealer Reports, 76 FR at 37589-37590.
---------------------------------------------------------------------------

    Exchange Act Rule 10b-10 specifies the information a broker-dealer
must disclose to customers on a trade confirmation at or before
completion of a securities transaction.\606\ Generally, Rule 10b-10
requires a confirmation to include, among other things: (1) The date
and time of the transaction and the identity, price, and number of
shares or units (or principal amount) of such security purchased or
sold by such customer; (2) the broker-dealer's capacity (agent or
principal) and its compensation; (3) the source and amount of any third
party remuneration it has received or will receive; and (4) other
information, both general (e.g., that the broker-dealer is not a SIPC
member, if such is the case) and transaction-specific (e.g., certain
yield information in most transactions involving debt securities).\607\
---------------------------------------------------------------------------

    \606\ 17 CFR 240.10b-10.
    \607\ Id.
---------------------------------------------------------------------------

    The information contained on a trade confirmation should reconcile
with customer statements and the broker-dealer's journal entries.\608\
In this regard, there is a link between trade confirmations sent by a
broker-dealer and the broker-dealer's records pertaining to custody of
customer assets.\609\ How a broker-dealer answers Item 5 could assist
examiners in focusing their inspections. For example, if the form
indicates that a third party is responsible for sending trade
confirmations, the examiners can confirm with that third party that it
is in fact sending confirmations.
---------------------------------------------------------------------------

    \608\ See 17 CFR 240.17a-3(a)(1), which requires the broker-
dealer to make ``[b]lotters (or other records of original entry)
containing an itemized daily record of all purchases and sales of
securities, all receipts and deliveries of securities (including
certificate numbers), all receipts and disbursements of cash and all
other debits and credits. Such records shall show the account for
which each such transaction was effected, the name and amount of
securities, the unit and aggregate purchase or sale price (if any),
the trade date, and the name or other designation of the person from
whom purchased or received or to whom sold or delivered.''
    \609\ Although broker-dealers may allocate the function of
sending confirmations to other broker-dealers or to service
providers, the allocating broker-dealer retains the responsibility
for sending confirmations. See New York Stock Exchange, Inc.; Order
Approving Proposed Rule Change, Exchange Act Release No. 18497 (Feb.
19, 1982), 47 FR 8284 (Feb. 25, 1982) at n.2 (providing ``no
contractual arrangement for the allocation of functions between an
introducing and carrying organization can operate to relieve either
organization from their respective responsibilities under the
federal securities laws and applicable SRO rules'').
---------------------------------------------------------------------------

    With respect to Item 5.A, one commenter requested clarification as
to whether a broker-dealer should indicate that it sends trade
confirmations directly to customers (by checking ``yes'') where it
employs a vendor to do so.\610\ The Commission has considered this
comment and determined that a broker-dealer should affirmatively
respond to Item 5 of Form Custody, as adopted, by checking the ``yes''
box on the form if it employs a vendor to send trade confirmations to
customers on its behalf because, in such an arrangement, the broker-
dealer is ultimately responsible for complying with its trade
confirmation obligations, not the vendor. The Commission has modified
the instructions to Item 5 to reflect this clarification.
---------------------------------------------------------------------------

    \610\ See SIFMA Letter.
---------------------------------------------------------------------------

6. Item 6--Account Statements
    Item 6 of proposed Form Custody would have required broker-dealers
to disclose whether they send account statements directly to customers
and other accountholders by checking the appropriate ``Yes'' or ``No''
box.\611\ The Commission received one comment on Item 6 of proposed
Form Custody.\612\ As is discussed below, the Commission is modifying
the instructions to Item 6 in response to this comment and is otherwise
adopting Item 6 as proposed.
---------------------------------------------------------------------------

    \611\ See Broker-Dealer Reports, 76 FR at 37590-37591.
    \612\ See SIFMA Letter.
---------------------------------------------------------------------------

    Account statements generally are sent to customers and other
accountholders on a monthly or quarterly basis and typically set forth
the assets held in the investor's securities account as of a specific
date and the transactions that occurred in the account during the
relevant period. SROs impose requirements on broker-dealers with
respect to the statements they must send to their customers.\613\ For
example, FINRA generally requires any member that conducts a general
securities business and also carries customer accounts or holds
customer funds or securities, at least once each calendar quarter, to
send an account statement to each customer whose account had a security
position, money balance, or account activity since the last statement
was sent.\614\ The account statement

must contain a description of any securities positions, money balances,
or account activity in the account. In addition, the account statement
must include a statement that advises the customer to report promptly
any inaccuracy or discrepancy in that person's account to the brokerage
firm.\615\ The statement also is required to advise the customer that
any oral communications made to the broker-dealer regarding
inaccuracies or discrepancies should be re-confirmed in writing to
further protect the customer's rights, including rights under
SIPA.\616\
---------------------------------------------------------------------------

    \613\ See, e.g., NASD Rule 2340.
    \614\ See NASD Rule 2340. NASD Rule 2340 defines a general
securities member as any member that conducts a general securities
business and is required to calculate its net capital pursuant to
Rule 15c3-1. NASD Rule 2340(d)(2). Additionally, NASD Rule 2340
defines account activity broadly so that it includes, but is not
limited to, purchases, sales, interest credits or debits, charges or
credits, dividend payments, transfer activity, securities receipts
or deliveries and/or journal entries relating to securities or funds
in the possession or control of the member. NASD Rule 2340(d)(1).
See also Order Approving Proposed Rule Change Relating to Rule 2340
Concerning Customer Account Statements, Exchange Act Release No.
54411 (Sept. 7, 2006), 71 FR 54105 (Sept. 13, 2006) (order granting
approval of a proposed rule change relating to Rule 2340 concerning
customer account statements).
    \615\ If the customer's account is serviced by both an
introducing broker-dealer and a clearing broker-dealer, the
statement must inform customers that such reports must be made to
both firms. See NASD Rule 2340(a).
    \616\ Id.
---------------------------------------------------------------------------

    Like trade confirmations, account statements are important
safeguards that allow investors to monitor transactions that occur in
their securities accounts. If the account statements are sent by a
broker-dealer other than the broker-dealer completing Form Custody,
this fact will need to be disclosed on the Form in Item 6.B. Item 6.C
asks whether the broker-dealer sends account statements to anyone other
than the beneficial owner of the account.\617\ In response to a request
for clarification raised by one commenter to proposed Item 6.C,\618\ a
broker-dealer also would check ``Yes'' to Item 6.C if the broker-dealer
sends account statements to the beneficial owner of an account and
duplicate account statements to persons other than the beneficial owner
of the account. The Commission has modified the instructions to Item 6
to reflect this clarification.
---------------------------------------------------------------------------

    \617\ Generally, the beneficial owner of an account represents
the person entitled to the economic benefits of ownership. With
respect to securities, the term beneficial owner is defined in Rule
13d-3 under the Exchange Act. See 17 CFR 240.13d-3.
    \618\ See SIFMA Letter.
---------------------------------------------------------------------------

    The Commission is requiring broker-dealers to answer the questions
in Item 6 to enhance its understanding of a broker-dealer's
relationship with customers, particularly in the context of the broker-
dealer's custodial responsibilities. Broker-dealers do not currently
disclose to the Commission whether they send account statements
directly to customers. Collecting this information on Form Custody will
provide examiners with additional background information that could be
used to refine the focus of their inspections. Further, the Commission
anticipates that examiners would make further inquiries to the extent
the Form reveals answers that are inconsistent with industry practice.
    A review of Item 6 also may facilitate an examiner's preparation
for an inspection. For example, if a broker-dealer indicates on Form
Custody that it holds customer accounts and sends account statements to
customers, the examiner could prepare a more targeted document request
to the broker-dealer. In this regard, an examiner could request
customer account statements from the broker-dealer, as well as
statements from the custodian(s) of the broker-dealer's customer
securities and cash.\619\ Examiners could then review and reconcile
these documents to verify whether customer securities and cash are held
at the custodian(s) identified by the broker-dealer.
---------------------------------------------------------------------------

    \619\ As is discussed above in section IV.C.3. of this release,
the fact that a broker-dealer uses a custodian to hold customer
securities and cash, and the type of custodian, will be disclosed in
response to Items 3.C and 3.D of Form Custody.
---------------------------------------------------------------------------

7. Item 7--Electronic Access to Account Information
    Item 7 of proposed Form Custody would have required broker-dealers
to indicate whether they provided customers and other accountholders
with electronic access to information about the securities and cash
positions in their accounts by checking the appropriate ``Yes'' or
``No'' box.\620\ Electronic access to account information can provide
investors with an efficient means of monitoring transactions that occur
in their securities accounts. This inquiry would inform the Commission
as to how readily customers are able to access and review their account
information. The Commission did not receive any comments to Item 7 of
proposed Form Custody and is adopting this Item as proposed.
---------------------------------------------------------------------------

    \620\ See Broker-Dealer Reports, 76 FR at 37591.
---------------------------------------------------------------------------

    The Commission believes that electronic access to account
information is beneficial to customers, who can more easily monitor the
performance of their accounts and perhaps more quickly identify any
discrepancies or inaccuracies. The Commission is including this Item in
Form Custody because it will help to inform examiners as to how readily
customers can access and review account information.
8. Item 8--Broker-Dealers Registered as Investment Advisers
    Item 8 of Form Custody, as proposed, would have elicited
information, if applicable, as to whether and how the broker-dealer
operated as an investment adviser.\621\ Proposed Item 8 was comprised
of three subparts, as described below.
---------------------------------------------------------------------------

    \621\ Id. at 37591-37592.
---------------------------------------------------------------------------

    The first question of Item 8--Item 8.A--would have required the
broker-dealer to indicate whether it was registered as an investment
adviser with the Commission under the Advisers Act or with one or more
states pursuant to the laws of a state.\622\ If the broker-dealer
indicated that it was registered with the Commission under the Advisers
Act or pursuant to state law (or both), then it would have been
required to respond to the remaining questions under Item 8.\623\
---------------------------------------------------------------------------

    \622\ Id. Section 203A of the Advisers Act prohibits certain
investment advisers from registering with the Commission based on
the advisers' assets under management, among other factors. See 17
CFR 275.203A.
    \623\ See Broker-Dealer Reports, 76 FR at 37591.
---------------------------------------------------------------------------

    The next question of Item 8 of proposed Form Custody--Item 8.B--
would have required the broker-dealer to disclose the number of its
investment adviser clients.\624\ This would provide the Commission with
information about the scale of the broker-dealer's investment adviser
activities.
---------------------------------------------------------------------------

    \624\ Id.
---------------------------------------------------------------------------

    The third question of Item 8 of proposed Form Custody--Item 8.C--
would have required the broker-dealer to complete a chart, consisting
of six columns, in which the broker-dealer would have provided
information about the custodians where the assets of the investment
adviser clients were held.\625\

In the first column, the broker-dealer would have been required to
disclose the name of the custodian, and in the second column, the
broker-dealer would have been required to identify the custodian by
either SEC file number or CRD number, as applicable.\626\
---------------------------------------------------------------------------

    \625\ Id. Under Rule 206(4)-2, it is a ``fraudulent, deceptive,
or manipulative act, practice or course of business'' for an
investment adviser registered or required to be registered under
section 203 of the Advisers Act (15 U.S.C. 80b-3) to have custody of
client funds or securities unless, among other things, a qualified
custodian maintains those funds or securities. See 17 CFR
275.206(4)-2(a)(1). A qualified custodian is: (1) A bank as defined
in section 202(a)(2) of the Advisers Act or savings association as
defined in section 3(b)(1) of the Federal Deposit Insurance Act (12
U.S.C. 1813(b)(1)) that has deposits insured by the Federal Deposit
Insurance Corporation under the Federal Deposit Insurance Act (2
U.S.C. 1811); (2) a broker-dealer registered under section 15(b)(1)
of the Exchange Act holding the client assets in customer accounts;
(3) an FCM registered under section 4f(a) of the Commodity Exchange
Act (7 U.S.C. 6f(a)), holding the client assets in customer
accounts, but only with respect to clients' funds and security
futures, or other securities incidental to transactions in contracts
for the purchase or sale of a commodity for future delivery and
options thereon; and (4) a foreign financial institution that
customarily holds financial assets for its customers, provided that
the foreign financial institution keeps the advisory clients' assets
in customer accounts segregated from its proprietary assets. See 17
CFR 275.206(4)-2(d)(6). A qualified custodian must maintain client
funds and securities: (1) In a separate account for each client
under that client's name; or (2) in accounts that contain only the
clients' funds and securities, under the investment adviser's name
as agent or trustee for the clients. See 17 CFR 275.206(4)-2(a)(1).
    \626\ See Broker-Dealer Reports, 76 FR at 37591.
---------------------------------------------------------------------------

    The third and fourth columns of the chart would have elicited
information about the scope of the broker-dealer/investment adviser's
authority over the accounts held at the custodian by requiring the
broker-dealer/investment adviser to check the appropriate ``Yes'' or
``No'' box.\627\ Specifically, in the third column, the broker-dealer/
investment adviser would have been required to indicate whether it had
the authority to effect transactions in the advisory client accounts at
the custodian. In the fourth column, the broker-dealer/investment
adviser would have been required to indicate whether it had the
authority to withdraw funds and securities from those accounts.
---------------------------------------------------------------------------

    \627\ Id.
---------------------------------------------------------------------------

    In the fifth column, the broker-dealer/investment adviser would
have been required to indicate whether the custodian sends account
statements directly to the broker-dealer's investment adviser
clients.\628\ The Commission recently adopted amendments to Rule
206(4)-2 to require that investment advisers have a reasonable basis,
after due inquiry, for believing that qualified custodians of advisory
client assets send account statements to the investment advisers'
clients. As stated in the release adopting that requirement, the
Commission believes that the direct delivery of account statements by
qualified custodians provides greater assurance of the integrity of
account statements received by clients.\629\
---------------------------------------------------------------------------

    \628\ Id.
    \629\ See, e.g., Custody of Funds or Securities of Clients by
Investment Advisers, 75 FR at 1465.
---------------------------------------------------------------------------

    In the sixth column, the broker-dealer/investment adviser would
have been required to indicate whether investment adviser client assets
were recorded on the broker-dealer's stock record.\630\ If the broker-
dealer was acting as custodian for such assets, the Commission
anticipates that those assets would be recorded on the broker-dealer's
stock record.\631\
---------------------------------------------------------------------------

    \630\ See Broker-Dealer Reports, 76 FR at 37591.
    \631\ If the broker-dealer acts as custodian for an investment
adviser client's securities, and does not record those securities on
its stock record, the broker-dealer would need to explain why those
securities were not recorded on its stock record in response to the
question in Item 3.D.ii of Form Custody.
---------------------------------------------------------------------------

    The Commission received one comment in response to Item 8 of Form
Custody, as proposed.\632\ This commenter stated that the information
sought in Item 8 was largely redundant with information collected from
investment advisers on Form ADV. The Commission is aware that some
overlap exists between the information collected from investment
advisers on Form ADV and the information that would be collected from
broker-dealers dually-registered as investment advisers in Item 8 of
proposed Form Custody. However, these two forms also contain a
significant amount of non-overlapping material, reflecting their
different purposes and uses. Form Custody is intended to be a single
source of readily-available information to assist Commission and DEA
examiners in preparing for and performing focused custody exams, and it
is particularly important that such information be readily available in
the case of dually-registered firms. Accordingly, the Commission is
adopting Item 8 of Form Custody substantially as proposed.\633\
---------------------------------------------------------------------------

    \632\ See Angel Letter.
    \633\ Column 2 of Item 8.C of Form Custody, as proposed, would
have required a broker-dealer/investment adviser to identify the SEC
File No. or CRD No. of each custodian where assets of investment
adviser clients were held. However, not all custodians of investment
adviser client assets have an SEC File No. or CRD No. Accordingly,
the instructions applicable to Column 2 of Item 8.C, as adopted,
have been modified to provide that a broker-dealer needs to identify
custodians in the column by SEC File No. or CRD No., ``if
applicable.'' Thus, a broker-dealer can leave Column 2 of Item 8.C
blank if assets of its investment adviser clients are held at a
custodian that does not have an SEC File No. or CRD No.
---------------------------------------------------------------------------

9. Item 9--Broker-Dealers Affiliated With Investment Advisers
    Item 9 of Form Custody consists of two subparts. Item 9.A, as
proposed, would have elicited information concerning whether the
broker-dealer was an affiliate of an investment adviser.\634\ Item
9.B.i, as proposed, would have elicited information from a broker-
dealer that checks ``Yes'' in response to Item 9.A to identify whether
it has custody of client assets of the adviser, and, if Item 9.B.i is
checked ``Yes,'' to indicate the approximate U.S. dollar market value
of the adviser client assets of which the broker-dealer has
custody.\635\ The Commission did not receive any comments to Item 9 of
proposed Form Custody and is adopting this Item as proposed. The
additional information obtained from a broker-dealer in response to
Item 9 will provide SEC and DEA examiners with a better understanding
of a broker-dealer's custody profile and, in particular, custodial
relationships with investment adviser affiliates.
---------------------------------------------------------------------------

    \634\ See Broker-Dealer Reports, 76 FR at 37592.
    \635\ Id.
---------------------------------------------------------------------------

    For purposes of Item 9, an affiliate is any person who directly or
indirectly controls the broker-dealer or any person who is directly or
indirectly controlled by or under common control with the broker-
dealer. Ownership of 25% or more of the common stock of the investment
adviser is deemed prima facie evidence of control.\636\
---------------------------------------------------------------------------

    \636\ See supra note 603 and corresponding text which specifies
the same ownership percentage on Form BD.
---------------------------------------------------------------------------

V. Effective Dates

    As discussed below, the Commission has established December 31,
2013 as the effective date for the requirement to file Form Custody and
the requirement to file annual reports with SIPC. The Commission is
delaying the effective date for the requirements relating to broker-
dealer annual reports to June 1, 2014. These delayed effective dates
are intended to provide time for broker-dealers, broker-dealer
independent public accountants, and broker-dealer DEAs to prepare for
the changes that will result from these new requirements. The
amendments relating to broker-dealer annual reports and the other
amendments to Rule 17a-5 (including the technical amendments) affect
numerous paragraphs in that rule and two paragraphs in Rule 17a-11.
Given the complexity and practical difficulty of having certain
provisions become effective before others, the amendments to Rule 17a-5
and the amendments to Rule 17a-11 will become effective on June 1,
2014, regardless of whether they relate to the annual report
requirements, except that there will be different effective dates for
the amendments to paragraph (a) of Rule 17a-5 (which includes the
filing requirement for Form Custody), Form Custody, the deletion of
paragraph (e)(5) of Rule 17a-5 (which sets forth the requirement to
file Form BD-Y2K), and the requirement to file annual reports with
SIPC. The effective dates for the remaining paragraphs of Rule 17a-5
and Rule 17a-11 are discussed further below.

A. Amendments Effective 60 Days After Publication in the Federal
Register

    Before today's amendments, paragraph (e)(5) of Rule 17a-5 required
a broker-dealer to file Form BD-Y2K, which elicits information with
respect to a broker-dealer's readiness for the year 2000 and any
potential problems that could arise with the advent of the new
millennium. The Commission is deleting this paragraph from Rule 17a-5
as the requirement is no longer applicable. The amendment deleting
paragraph (e)(5) of Rule 17a-5 will be effective 60 days after this
release is published in the Federal Register.

B. Amendments Effective on December 31, 2013

    The amendments to paragraph (a) of Rule 17a-5 and the rule
establishing Form Custody (17 CFR 249.639) are effective on December
31, 2013. The amendments to paragraph (a) include the requirement for a
broker-dealer to file Form Custody with its DEA.\637\ Consequently,
broker-dealers subject to this filing requirement must begin filing
Form Custody with their DEAs 17 business days after the calendar
quarter or fiscal year, as applicable, ended December 31, 2013.
---------------------------------------------------------------------------

    \637\ See paragraph (a)(5) of Rule 17a-5.
---------------------------------------------------------------------------

    Two commenters requested that the Commission provide broker-dealers
with sufficient time to develop, test, and implement the systems that
they will use to comply with the Form Custody filing requirements.\638\
The Commission understands that broker-dealers will need to allocate
personnel and systems resources to comply with the Form Custody filing
requirements, particularly for a broker-dealer's initial filing. DEAs
also will need to be prepared to receive the forms that are filed by
broker-dealers. Establishing December 31, 2013 as the effective date of
the Form Custody requirements is designed to accommodate the efforts
that need to be undertaken by both broker-dealers and DEAs in
connection with the filing and receipt of Form Custody.
---------------------------------------------------------------------------

    \638\ See E&Y Letter; SIFMA Letter.
---------------------------------------------------------------------------

    Additionally, the amendment to paragraph (d)(6) of Rule 17a-5 is
effective on December 31, 2013. Broker-dealer annual reports must be
filed with SIPC for fiscal years ending on or after December 31, 2013.

C. Amendments Effective on June 1, 2014

    The amendments to paragraphs (b), (c), (d)(1), (d)(2), (d)(3),
(d)(4), (d)(5), (e)(1), (e)(2), (e)(3), (e)(4), (f), (g), (h), (i),
(k), (l), (m) and (n) and the deletion of paragraph (j) of Rule 17a-5
and the amendments to Rule 17a-11 are effective on June 1, 2014.
Consequently, all of the amendments to Rule 17a-5 not discussed above
in sections V.A. and V.B. of this release and the amendments to Rule
17a-11 are effective on that date. This includes the amendments
relating to the annual report requirements, with the exception of the
requirement to file annual reports with SIPC, which is effective on
December 31, 2013. In 2014, therefore, the annual report requirements
will apply to all broker-dealers subject to these requirements that
have a fiscal year ending on or after June 1, 2014.
    The Commission proposed that the amendments would apply for fiscal
years ending on or after December 15, 2011, with a first-year
transition period for carrying broker-dealers required to file
compliance reports with fiscal years ending on or after December 15,
2011 but before September 15, 2012.\639\ The Commission received 14
comments concerning the compliance date of the amendments.\640\ Most
commenters recommended that the Commission delay the compliance date.
One commenter, however, stated that broker-dealers should start working
on compliance immediately.\641\ Several stated that the compliance date
of the amendments should be aligned with the effective date of the
proposed PCAOB standards for engagements related to compliance reports
and exemption reports.\642\ One commenter suggested that the Commission
postpone the assertion requirements until the rule has been in effect
for one year.\643\ Another commenter stated that the rules should be
effective for fiscal years ending on or before December 15, 2012 ``to
allow sufficient time to complete robust documentation and testing of
the processes related to the Financial Responsibility Rules and the
Financial Statements.'' \644\ Similarly, another commenter stated that
the effective date should be deferred to fiscal years ending on or
before December 15, 2012 ``to give broker-dealers and their auditors
time to adequately address the final rules,'' and that the effective
date should be aligned with the effective date of PCAOB standards.\645\
Another commenter stated that the rule amendments should apply only to
annual reports filed on or after December 15, 2012, and that
implementation of the proposal must be postponed until after the PCAOB
establishes auditing and attestation standards and broker-dealers have
had ample time to plan and budget for the new standards.\646\ Finally,
a commenter stated that broker-dealers should be required to file the
first compliance report or exemption report no earlier than one quarter
after the adoption of the final rule amendments and to report
identified instances of material non-compliance or material weaknesses
in annual reports filed no earlier than five quarters after the
adoption of the final rule amendments, with a transition period as
proposed of no less than five quarters after the adoption of the final
rule amendments.\647\ This commenter also suggested that the Commission
require the filing of the first Form Custody no earlier than three
quarters after the effective date of the final rule.\648\
---------------------------------------------------------------------------

    \639\ See Broker-Dealer Reports, 76 FR at 37581. During the
transition period, the statement in the compliance report as to
whether internal control was effective would have been a point-in-
time statement as of the date of the report, rather than covering
the entire fiscal year.
    \640\ See, e.g., ABA Letter; AICPA Letter; CAQ Letter; Citrin
Letter; Deloitte Letter; E&Y Letter; Grant Thornton Letter; KPMG
Letter; McGladrey Letter; PWC Letter; SIFMA Letter; Shatto Letter;
CAI Letter; Van Kampen/Invesco Letter.
    \641\ See Shatto Letter.
    \642\ See, e.g., CAQ Letter; Deloitte Letter; Grant Thornton
Letter; KPMG Letter; McGladrey Letter.
    \643\ See ABA Letter.
    \644\ See Van Kampen/Invesco Letter.
    \645\ See E&Y Letter.
    \646\ See CAI Letter.
    \647\ See SIFMA Letter.
    \648\ Id.
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    The amendments, among other things, establish important new
safeguards with respect to broker-dealer custody of customer funds and
securities. However, the Commission recognizes that broker-dealers and
other affected parties may need additional time to prepare to comply
with the new requirements.
    Amendments to provisions regarding broker-dealer annual reports and
the engagement of an independent public accountant in paragraphs
(d)(1), (d)(2), (d)(3), (d)(4), (d)(5), (e)(1), (e)(2), (e)(3), (e)(4),
(g), and (i) of Rule 17a-5 and the deletion of paragraph (j) of Rule
17a-5 generally will apply for broker-dealers with fiscal years ending
on or after June 1, 2014. In particular, broker-dealers must file
compliance reports or exemption reports, as applicable, and broker-
dealers must file reports of independent public accountants covering
compliance reports or exemption reports in accordance with Rule 17a-5
as amended, for fiscal years ending on or after June 1, 2014, with no
transition period. Similarly, PCAOB standards, rather than GAAS, apply
to examinations of financial reports for fiscal years ending on or
after June 1, 2014. For broker-dealers with fiscal years that end
before June 1, 2014,

applicable reports must be filed in accordance with the provisions of
Rule 17a-5 as they existed before today's amendments.
    Amendments to the customer statement provisions of paragraph (c) of
Rule 17a-5 apply for fiscal years ending on or after June 1, 2014, and
in the interim broker-dealers must comply with those provisions as they
existed before today's amendments.
    Paragraph (f)(2) of Rule 17a-5 requires a broker-dealer to file a
statement regarding its independent public accountant on December 10 of
each year. As a result of today's amendments, all broker-dealers that
are required by Rule 17a-5 to engage an independent public accountant
must file a new statement by December 10, 2013 that contains the
information and representations required under paragraph (f)(2) of Rule
17a-5 as amended. For example, after today's amendments, the statement
must include a representation that the accountant has undertaken the
engagement of the accountant provisions of paragraph (g) of Rule 17a-5
as amended. The statement also must include, if applicable,
representations regarding access to the broker-dealer's independent
public accountant and the audit documentation of the independent public
accountant.
    The amendments to the notification provisions in paragraph (h) of
Rule 17a-5 and amendments to Rule 17a-11 are effective on June 1, 2014.
In the interim, these provisions as they existed before today's
amendments continue to apply.
    Finally, the amendments to paragraphs (b), (c), (d)(1), (d)(2),
(d)(3), (d)(4), (d)(5), (e)(1), (e)(2), (e)(3), (e)(4), (f), (g), (h),
(i), (k), (l), (m), and (n) of Rule 17a-5 and the amendments to Rule
17a-11 not discussed above, including technical amendments, are
effective on June 1, 2014.
    With respect to the annual report requirements, the June 1, 2014
effective date should provide sufficient time for the PCAOB to
finalize, and for the Commission to consider, proposed standards
applicable to broker-dealer examinations and reviews and for broker-
dealers and their accountants to become familiar with, and be prepared
to comply with, those standards. The Commission has chosen a specific
effective date, instead of aligning that date with the date of adoption
of the rule amendments or the date that the Commission approves PCAOB
standards applicable to broker-dealer examinations and reviews, as
suggested by commenters, to provide certainty regarding the date by
which broker-dealers and their accountants must comply with the new
requirements. Certain commenters referenced AICPA guidance with respect
to broker-dealer audits. However, this guidance will no longer be
applicable for fiscal years ending on or after June 1, 2014, when
standards of the PCAOB begin to apply.
    One commenter suggested that the effective date for non-carrying
and smaller broker-dealers to comply with amendments to the annual
reporting requirements should be one year after the adoption of the
amendments.\649\ The Commission notes that most smaller broker-dealers
are non-carrying firms and, therefore, will be required to file the
exemption report and a report of the independent public accountant
based on a review of the exemption report. As discussed in sections VI.
and VII. of this release, the hour burdens and costs of the exemption
report requirements will be substantially less than the hour burdens
and costs of the compliance report requirements. Consequently, the
Commission does not believe the effective date should be extended
further for smaller broker-dealers.
---------------------------------------------------------------------------

    \649\ See Citrin Letter.
---------------------------------------------------------------------------

    As stated above, another commenter suggested that the Commission
postpone the assertion requirements until the rule has been in effect
for one year.\650\ The Commission recognizes that all broker-dealers
subject to these requirements and their independent public accountants
will need time to prepare to comply with the requirements. The
effective date the Commission is establishing should provide sufficient
time for small or non-carrying firms, as well as larger carrying firms,
to prepare for compliance with the new requirements.
---------------------------------------------------------------------------

    \650\ See ABA Letter.
---------------------------------------------------------------------------

VI. Paperwork Reduction Act

    Certain provisions of the final rule amendments contain
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\651\ The Commission
solicited comment on the estimated burden associated with the
collection of information requirements in the proposed amendments.\652\
The Commission submitted the proposed collection of information
requirements to the Office of Management and Budget (``OMB'') for
review in accordance with 44 U.S.C. 3507 and 5 CFR 1320.11.
---------------------------------------------------------------------------

    \651\ 44 U.S.C. 3501 et seq.
    \652\ See Broker-Dealer Reports, 76 FR at 37594-37598.
---------------------------------------------------------------------------

    The titles and OMB control numbers for the collections of
information are:
    (1) Rule 17a-5, Reports to be made by certain brokers and dealers
(OMB Control Number 3235-0123);
    (2) Rule 17a-11, Notification provisions for brokers and dealers
(OMB Control Number 3235-0085); and
    (3) Form Custody (OMB Control Number 3235-0691).
    An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information requirement unless it
displays a currently valid OMB control number. As discussed above, the
Commission received 27 comment letters on the proposed rulemaking. Some
of these comments relate directly or indirectly to the PRA. These
comments are addressed below. Finally, some initial burden estimates
have been adjusted, as discussed below, to reflect updated information
used to make the estimates.

A. Summary of the Collection of Information Requirements

    As discussed in greater detail above in sections II., III., and IV.
of this release, the Commission is adopting amendments to Rules 17a-5
and 17a-11 and is adopting new Form Custody for broker-dealers to file
with their DEA.
    Under the amendments to Rule 17a-5, broker-dealers must, among
other things, file with the Commission annual reports consisting of a
financial report and one of two new reports--either a compliance report
or an exemption report that are prepared by the broker-dealer, and
generally must also file reports prepared by an independent public
accountant registered with the PCAOB covering those reports in
accordance with PCAOB standards.\653\ The financial report must contain
the same types of financial statements that were required to be filed
under Rule 17a-5 prior to these amendments (a statement of financial
condition, a statement of income, a statement of cash flows, and
certain other financial statements).\654\ In addition, the financial
report must contain, as applicable, the supporting schedules that were
required to be filed under Rule 17a-5 prior to these amendments (a
computation of net capital under Rule 15c3-1, a computation of the
reserve requirements under Rule 15c3-3, and information relating to the
possession or control requirements under Rule 15c3-3).
---------------------------------------------------------------------------

    \653\ See discussion above in sections II.B.1., II.B.2.,
II.B.3., and II.B.4. of this release.
    \654\ See discussion above in section II.B.2. of this release.
---------------------------------------------------------------------------

    A broker-dealer that does not claim an exemption from Rule 15c3-3
through the most recent fiscal year--generally a carrying broker-
dealer--must file the compliance report, and a broker-dealer that
claimed an exemption from Rule 15c3-3 throughout the most recent

fiscal year must file the exemption report. In the compliance report
and exemption report, a broker-dealer must make certain statements and
provide certain information relating to the financial responsibility
rules.
    In addition to preparing and filing the financial report and the
compliance report or exemption report, a broker-dealer must engage a
PCAOB-registered independent public accountant to prepare a report
based on an examination of the broker-dealer's financial report in
accordance with PCAOB standards.\655\ A broker-dealer that files a
compliance report also must engage the PCAOB-registered independent
public accountant to prepare a report based on an examination of
certain statements in the compliance report.\656\ A broker-dealer that
files an exemption report must engage the PCAOB-registered independent
public accountant to prepare a report based on a review of certain
statements in the broker-dealer's exemption report. In each case, the
examination or review must be conducted in accordance with PCAOB
standards. A broker-dealer must file these reports of the independent
public accountant with the Commission along with the financial report
and the compliance report or exemption report prepared by the broker-
dealer.
---------------------------------------------------------------------------

    \655\ See discussion above in section II.D.3. of this release.
    \656\ See paragraphs (f)(1) and (g)(2)(i) of Rule 17a-5.
---------------------------------------------------------------------------

    The amendments add a requirement that the annual reports also be
filed with SIPC if the broker-dealer is a member of SIPC.\657\ In
addition, broker-dealers must generally file with SIPC a supplemental
report on the status of the membership of the broker-dealer in
SIPC.\658\ The supplemental report must include a report of the
independent public accountant based on certain procedures specified in
the rule in accordance with PCAOB standards. In the future, SIPC may
determine the format of this report by rule, subject to Commission
approval.
---------------------------------------------------------------------------

    \657\ See discussion above in section II.B.6. of this release.
    \658\ See discussion above in section II.C.4. of this release.
---------------------------------------------------------------------------

    Under the amendments, the PCAOB-registered independent public
accountant must immediately notify the broker-dealer if the accountant
determines during the course of preparing the accountant's reports that
the broker-dealer was not in compliance at any time during the fiscal
year with the financial responsibility rules or if the accountant
determines that any material weakness existed in the broker-dealer's
Internal Control Over Compliance during the fiscal year.\659\ The
broker-dealer, in turn, must file a notification with the Commission
and its DEA under Rule 15c3-1, Rule 15c3-3, or Rule 17a-11 if the
accountant's notice concerns an instance of non-compliance that would
trigger notification under those rules. Under amendments to Rule 17a-
11, a broker-dealer also must file a notification with the Commission
and its DEA if the accountant's notice concerns (or if the broker-
dealer discovers) a material weakness in the broker-dealer's Internal
Control Over Compliance.
---------------------------------------------------------------------------

    \659\ See discussion above in section II.F. of this release.
---------------------------------------------------------------------------

    The amendments also require a broker-dealer that clears
transactions or carries customer accounts to agree to allow
representatives of the Commission or the broker-dealer's DEA to review
the documentation associated with the reports of the broker-dealer's
independent public accountant and to allow the accountant to discuss
its findings with the representatives, if requested in writing for
purposes of an examination of the broker-dealer.\660\
---------------------------------------------------------------------------

    \660\ See discussion above in section III. of this release.
---------------------------------------------------------------------------

    Finally, the amendments require broker-dealers to file a new Form
Custody, which elicits information concerning the custody practices of
the broker-dealer.\661\ Form Custody must be filed with the DEA each
quarter. 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.
---------------------------------------------------------------------------

    \661\ See discussion above in section IV. of this release.
---------------------------------------------------------------------------

    The burdens associated with the collection of information
requirements in the amendments are discussed below.

B. Use of Information

    The proposed amendments relating to the reports to be filed by the
broker-dealer are designed to enhance the ability of the Commission to
oversee broker-dealer custody practices and, among other things, to:
(1) Increase the focus of carrying broker-dealers and their independent
public accountants on compliance, and internal control over compliance,
with the financial responsibility rules; (2) facilitate the ability of
the PCAOB to implement the explicit oversight authority of broker-
dealer audits provided to the PCAOB by the Dodd-Frank Act; and (3) with
respect to broker-dealers that are dually-registered as investment
advisers, satisfy the internal control report requirement that was
added by the amendment to Rule 206(4)-2 noted above with the
accountant's report based on an examination of the compliance report.
Securities regulators will use these reports to monitor the financial
condition of broker-dealers. In addition, the components of the reports
that are made public may be used by investors to review the financial
condition of broker-dealers with which they have accounts or obtain
other securities related services. SIPC can use the annual reports to
monitor the financial strength of broker-dealers and to assess the
adequacy of the SIPC Fund.
    The amendment requiring a broker-dealer that clears transactions or
carries customer accounts to allow Commission and DEA examination staff
to review the audit documentation associated with its annual audit
reports required under Rule 17a-5 and to allow its independent public
accountant to discuss findings relating to the audit reports with
Commission and DEA examination staff is intended to facilitate
examinations of clearing broker-dealers by Commission and DEA
examination staff. Commission and DEA examiners will use the
information obtained from audit documentation and discussions with the
broker-dealer's independent public accountant to plan their
examinations.
    Finally, Commission and DEA examiners will use Form Custody to
understand a broker-dealer's custody profile and identify custody-
related violations and misconduct. For example, if a broker-dealer
represents on Form Custody that it does not issue account statements,
but an examiner discovers that an account statement has been issued by
the broker-dealer (e.g., in connection with a customer complaint or in
the course of an examination of the broker-dealer), the examiner will
be able to react more quickly to the misrepresentation. Further, the
requirement to prepare and file the form should motivate broker-dealers
to focus more attention on their custody practices.

C. Respondents

    The Commission estimated in the proposal that there were 5,063
registered broker-dealers that would be affected by the proposed
amendments and that, of these, 305 were carrying broker-dealers, 528
were carrying or clearing broker-dealers, and 4,752 were broker-dealers
that claimed exemptions from Rule 15c3-3.\662\ The Commission did not
receive comments regarding these estimates, but the Commission has

updated the estimates to reflect more recent information.\663\
---------------------------------------------------------------------------

    \662\ See Broker-Dealer Reports, 76 FR at 37595.
    \663\ The updated estimates are based on FOCUS Report data as of
year end 2011. As discussed above, FOCUS Reports are deemed
confidential pursuant to paragraph (a)(3) of Rule 17a-5.
---------------------------------------------------------------------------

    As of December 31, 2011, 4,709 broker-dealers filed FOCUS Reports
with the Commission. Of these, 4,417 broker-dealers claimed exemptions
from Rule 15c3-3. Consequently, the Commission estimates that there are
approximately 292 carrying broker-dealers (4,709 - 4,417 = 292). Based
on FOCUS Report data, the Commission further estimates that there are
approximately 513 carrying or clearing broker-dealers. According to
SIPC, as of March 31, 2012, 217 broker-dealers claimed exemptions from
SIPC membership. Therefore, the Commission estimates that 4,492 (4,709
- 217 = 4,492) broker-dealers are members of SIPC.

D. Total Initial and Annual Burdens

    As discussed in detail below, the Commission estimates that the
total PRA burden resulting from the amendments to Rules 17a-5 and 17a-
11 and new Form Custody include an initial, one-time burden of
approximately 13,522 hours \664\ and an annual burden of approximately
276,717 hours.\665\ There is significant variance between the largest
broker-dealers and the smallest broker-dealers. Consequently, the
estimates described below are averages across all types of broker-
dealers expected to be affected by the amendments.
---------------------------------------------------------------------------

    \664\ As discussed below, the total one-time burden relates to
the requirement to draft and file a revised statement regarding the
independent public accountant under Rule 17a-5(f)(2). The Commission
estimated a total one-time burden of 10,214 hours in the proposing
release for the statement regarding the independent public
accountant and for SIPC forms. See Broker-Dealer Reports, 76 FR at
37595.
    \665\ As discussed below, the total annual hour burden relates
to the compliance report (17,520 hours), the exemption report
(30,919 hours), the filing of annual reports with SIPC (2,246
hours), and Form Custody (226,032 hours). The Commission estimated a
total annual burden of 287,325 hours in the proposing release. See
Broker-Dealer Reports, 76 at FR 37595.
---------------------------------------------------------------------------

1. Annual Reports To Be Filed
i. The Financial Report
    The Commission's amendments to Rule 17a-5 retain the current
requirement that broker-dealers annually file financial statements and
supporting schedules that must be audited by a PCAOB-registered
accountant. As a result, the Commission's estimate of the hour burden
for broker-dealers to prepare and file the financial report has not
changed as a result of the amendments to Rule 17a-5.
ii. The Compliance Report
    Under the amendments, a carrying broker-dealer must prepare and
file with the Commission a new compliance report each year. The
compliance report must contain statements as to whether: (1) The
broker-dealer has established and maintained Internal Control Over
Compliance; (2) the Internal Control Over Compliance of the broker-
dealer was effective during the most recent fiscal year; (3) the
Internal Control Over Compliance of the broker-dealer was effective as
of the end of the most recent fiscal year; (4) the broker-dealer was in
compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3 as of the
end of the most recent fiscal year; and (5) the information the broker-
dealer used to state whether it was in compliance with Rule 15c3-1 and
paragraph (e) of Rule 15c3-3 was derived from the books and records of
the broker-dealer. In addition, if applicable, the compliance report
must contain a description of: (1) Each identified material weakness in
the broker-dealer's Internal Control Over Compliance during the most
recent fiscal year, including those that were identified as of the end
of the fiscal year; and (2) any instance of non-compliance with Rule
15c3-1 or paragraph (e) of Rule 15c3-3 as of the end of the most recent
fiscal year.
    The Commission estimated that, on average, carrying broker-dealers
would spend approximately 60 hours each year to prepare the compliance
report, as proposed.\666\
---------------------------------------------------------------------------

    \666\ See Broker-Dealer Reports, 76 FR at 37596.
---------------------------------------------------------------------------

    One commenter stated that the proposal did not ``address the
additional costs broker-dealers would incur in preparing Compliance
Reports.''\667\ The commenter, however, did not comment directly on the
estimated hour burden or provide specific examples of costs, in
addition to the hour burdens, that broker-dealers would bear.\668\
Another commenter also stated that the proposed estimate of 60 hours
``is not an accurate estimate of the time burden to complete the
Compliance Report'' and that the burdens in the proposing release are
understated.\669\ The commenter stated that completing the compliance
report will require extensive collaboration between management,
internal audit and the independent public accountants resulting in
added hours to perform the validation and evidence gathering of the
existing processes necessary to make the assertions in the proposed
compliance report.\670\ The commenter, however, did not provide a
different estimate of the number of hours it would take to complete the
compliance report.
---------------------------------------------------------------------------

    \667\ See SIFMA Letter.
    \668\ Id.
    \669\ See Van Kampen/Invesco Letter.
    \670\ Id.
---------------------------------------------------------------------------

    In response to these comments, the Commission notes that the final
rule modifies the proposal in ways that may modestly reduce the time
burden. For example, the final rule requires a statement as to whether
the broker-dealer was in compliance with Rule 15c3-1 and paragraph (e)
of Rule 15c3-3 as of the end of the most recent fiscal year and, if
applicable, a description of any instances of non-compliance with these
rules as of the fiscal year end, rather than the proposed assertion
that the broker-dealer is in compliance with the financial
responsibility rules in all material respects and proposed description
of any material non-compliance with the financial responsibility rules.
This reflects two changes from the proposal: (1) Elimination of the
concepts of ``material non-compliance'' and ``compliance in all
material respects'' with Rule 15c3-1 and 15c3-3 for the purposes of
reporting in the compliance report; and (2) a narrowing of these
statements and description requirements from compliance with all of the
financial responsibility rules to compliance with Rule 15c3-1 and
paragraph (e) of Rule 15c3-3.
    As modified, the final rule no longer requires the broker-dealer to
evaluate whether an instance of non-compliance with the financial
responsibility rules was material, a component of the proposal that
generated significant comment. In addition, the broker-dealer only
needs to report instances of non-compliance with Rule 15c3-1 and
paragraph (e) of Rule 15c3-3. In this regard, broker-dealers currently
are required to include supporting schedules to their financial
statements containing a computation of net capital and the reserve
requirement under paragraph (e) of Rule 15c3-3. Consequently, the work
required under this pre-existing requirement should provide the broker-
dealer with the information it needs to make the statement as to
whether it is in compliance with Rule 15c3-1 and paragraph (e) of Rule
15c3-3 as of the fiscal year end.
    Given these modifications, the statements in the compliance report
concerning the broker-dealer's Internal Control Over Compliance likely
will be responsible for the bulk of the hour burden associated with
preparing the

compliance report. For example, the broker-dealer will need to evaluate
whether its Internal Control Over Compliance with the financial
responsibility rules was effective during the most recent fiscal year.
    The Commission believes that the modifications to the final rule
discussed above may modestly reduce the hour burden of the final rule
as compared to the hour burden that would have resulted from the
proposed rule; namely, because a broker-dealer will not need to
evaluate whether instances of non-compliance with the financial
responsibility rules are material and will only need to report
instances of non-compliance with Rule 15c3-1 and paragraph (e) of Rule
15c3-3. In light of the comments suggesting that the proposing release
underestimated the burden, the Commission is not reducing the hour
burden estimate for the rule to reflect the potential reduction in hour
burden associated with the requirement. Thus, to the extent the
proposing release underestimated the burden associated with making the
statements in the compliance report about the broker-dealer's Internal
Control Over Compliance, the amount of the burden reduction realized
through the modifications discussed above is now attributed to the
burden associated with the statements about Internal Control Over
Compliance.
    For these reasons, the Commission is retaining the rule's overall
hour burden estimate without revision. The Commission, however, is
updating the number of carrying broker-dealers to reflect more recently
available data from the broker-dealer FOCUS Reports. The Commission now
estimates that there are 292 carrying broker-dealers. Consequently, the
Commission estimates that the total annual reporting burden to prepare
and file the compliance report is approximately 17,520 hours per year
for all carrying broker-dealers.\671\
---------------------------------------------------------------------------

    \671\ 60 hours x 292 carrying broker-dealers = 17,520 hours. See
the discussion below regarding the external costs associated with
obtaining the accountant's report on the compliance report.
---------------------------------------------------------------------------

iii. The Exemption Report
    Under the amendments, a non-carrying broker-dealer must file the
exemption report.\672\ In the exemption report, the broker-dealer must
provide to its best knowledge and belief: (1) A statement that
identifies the provisions in paragraph (k) of Rule 15c3-3 under which
the broker-dealer claimed an exemption from Rule 15c3-3; (2) a
statement that the broker-dealer met the identified exemption
provisions in paragraph (k) throughout the most recent fiscal year
without exception or that it met the identified exemption provisions in
paragraph (k) throughout the most recent fiscal year except as
described in the exemption report; and (3) if applicable, a statement
that identifies each exception during the most recent fiscal year in
meeting the identified provisions in paragraph (k) and that briefly
describes the nature of each exception and the approximate date(s) on
which the exception existed.
---------------------------------------------------------------------------

    \672\ See discussion above in sections II.B.1. and II.B.4. of
this release.
---------------------------------------------------------------------------

    The Commission estimated that it would take a non-carrying broker-
dealer approximately five hours to prepare and file the proposed
exemption report.\673\ The Commission did not receive any comments on
this hour estimate. As discussed above in section II.B.4. of this
release, the Commission is adopting, with modifications, the
requirements regarding the exemption report. These provisions generally
clarified the scope and application of the report. However, one
modification provides that if the broker-dealer states that it met the
identified exemption provisions in paragraph (k) of Rule 15c3-3
throughout the most recent fiscal year except as described in the
report, the broker-dealer must identify each exception during the most
recent fiscal year in meeting the identified provisions in paragraph
(k) of Rule 15c3-3 and that briefly describes the nature of each
exception and the approximate date(s) on which the exception existed.
The Commission expects that non-carrying broker-dealers generally track
exceptions as part of monitoring compliance with the exemption
provisions in paragraph (k) of Rule 15c3-3. The requirement to identify
and describe exceptions would create an incremental burden over the
rule as proposed. Based on staff experience with the application of
Rule 17a-5, the Commission estimates that the additional work
associated with describing exceptions in the exemption report would
take two hours. Therefore, the Commission is revising the hour estimate
associated with the exemption report to seven hours.
---------------------------------------------------------------------------

    \673\ See Broker-Dealer Reports, 76 FR at 37596.
---------------------------------------------------------------------------

    The Commission now estimates that there are approximately 4,417
non-carrying broker-dealers that must file exemption reports.
Therefore, the Commission estimates that the annual reporting burden
for all non-carrying broker-dealers to prepare and file the exemption
report is approximately 30,919 hours per year.\674\
---------------------------------------------------------------------------

    \674\ 7 hours x 4,417 non-carrying broker-dealers = 30,919
hours. See the discussion below regarding the external costs
associated with obtaining the accountant's report on the exemption
report.
---------------------------------------------------------------------------

iv. Additional Burden and Cost To File the Annual Reports
    The filing requirements for the annual reports are being
amended.\675\ In particular, Rule 17a-5 previously provided that a
broker-dealer must file two copies of its annual reports with the
Commission's principal office in Washington, DC. The final rule no
longer requires that two copies be filed, so that, in accordance with
paragraph (d)(6) of Rule 17a-5, broker-dealers must file only one copy
of the annual reports with the Commission's principal office. This
change could reduce slightly the hour burden and cost associated with
filing the annual reports with the Commission.\676\
---------------------------------------------------------------------------

    \675\ See discussion above in section II.B.6. of this release.
    \676\ The Commission does not expect the compliance report,
exemption report, and related reports of the independent public
accountant to increase the mailing costs of the annual reports
because these additional reports in the aggregate should not
significantly increase the size and weight of the package of annual
reports.
---------------------------------------------------------------------------

    Amendments to paragraph (d)(6) of Rule 17a-5 require that a broker-
dealer also file a copy of its annual reports with SIPC. The Commission
estimated that it would take 30 minutes to prepare an additional copy
of the annual reports and mail it to SIPC as required by the proposed
amendments.\677\ The Commission did not receive comments regarding this
estimate. In addition, the clarification to the final rule that only
broker-dealers that are members of SIPC must file a copy of their
annual reports with SIPC will not affect the final PRA hour burden
estimate. Therefore, the Commission is retaining this estimate without
revision. The Commission now estimates that 4,492 broker-dealers are
members of SIPC.\678\ Therefore, the Commission estimates that the
annual industry-wide reporting burden associated with this amendment is
approximately 2,246 hours per year.\679\
---------------------------------------------------------------------------

    \677\ See Broker-Dealer Reports, 76 FR at 37596.
    \678\ As discussed in subsection C. above, according to SIPC, as
of March 31, 2012, 217 broker-dealers claimed exemptions from SIPC
membership. The Commission therefore estimates that 4,492 (4,709-217
= 4,492) broker-dealers are members of SIPC.
    \679\ \1/2\ hour x 4,492 broker-dealers = 2,246 hours.
---------------------------------------------------------------------------

    There would be postage costs associated with sending a copy of the
annual reports to SIPC that are estimated to be, on average,\680\
approximately $12.05 per broker-dealer

per year.\681\ Thus, the Commission estimates that the total annual
postage costs associated with sending a copy of the annual reports to
SIPC would be approximately $54,128 per year for all broker-dealers
that are SIPC members.\682\
---------------------------------------------------------------------------

    \680\ The number of pages of an annual report, and consequently
the associated postage costs, likely will vary significantly based
on the size of the broker-dealer and the types of business in which
it engages.
    \681\ Based on Commission staff experience with annual report
filings of broker-dealers under Rule 17a-5, the Commission staff
estimates that approximately 50% of broker-dealers file their annual
reports using an overnight mail delivery service. These broker-
dealers would consequently incur higher postage costs than broker-
dealers which choose to mail their annual reports using first class
mail or delivery methods other than overnight mail. Therefore,
postage costs will vary depending on the size of the annual report
and method of delivery. The Commission estimates that the cost to
mail the additional reports would be, on average, $12.05 per broker-
dealer. As of October 2012, the $12.05 rate is an average rate of
the cost of an Express Mail Flat Rate Envelope of $18.95 and a
Priority Mail Flat Rate Envelope of $5.15, based on costs obtained
on the Web site of the U.S. Postal Service at: www.usps.gov. ($18.95
+ $5.15) = $24.10/2 = $12.05.
    \682\ 4,492 broker-dealers x $12.05 = $54,128.
---------------------------------------------------------------------------

    Finally, the Commission notes that paragraph (d)(1)(ii) of Rule
17a-5 of the final rule was amended to require that a copy of a DEA's
written approval to change a broker-dealer's fiscal year end must be
sent to the Commission's principal office in Washington DC, in addition
to the regional office of the Commission for the region in which the
broker-dealer has its principal place of business. Based on the number
of copies of approvals received by the Commission and staff experience
in the application of Rule 17a-5, the Commission estimates that
approximately 75 broker-dealers will receive approval each year to
change their fiscal year end. The Commission estimates that it would
take 10 minutes to copy and send an additional copy of the approval to
the Commission's principal office in Washington, DC for a total
industry-wide annual hour burden of approximately 12.5 hours,\683\ and
a total industry-wide cost of approximately $33.75 per year to mail the
approval.\684\
---------------------------------------------------------------------------

    \683\ (75 approvals x 10 minutes)/60 = 12.5 hours.
    \684\ 75 approvals x $0.45 (current price of a letter sent first
class) = $33.75.
---------------------------------------------------------------------------

v. Supplemental Report on SIPC Membership
    Prior to today's amendments, paragraph (e)(4) of Rule 17a-5
provided that a broker-dealer must file with its annual report a
supplemental report on the status of the membership of the broker-
dealer in SIPC, which was required to be ``covered by an opinion of the
independent public accountant'' if the annual report of the broker-
dealer was required to be audited. The Commission is adopting
amendments to paragraph (e)(4) of Rule 17a-5 to provide that broker-
dealers must file with SIPC--but no longer with the Commission after an
interim period if SIPC adopts a rule under paragraph (e)(4)(i) that is
approved by the Commission--a report of an independent public
accountant designed to help administer the collection of assessments
from broker-dealers for purposes of establishing and maintaining SIPC's
broker-dealer liquidation fund.\685\ The Commission is adopting the
proposed amendments to paragraph (e)(4) of Rule 17a-5 substantially as
proposed. One modification is that, as adopted, the final rule provides
that the accountant must perform the procedures specified in the rule
in accordance with PCAOB standards. SIPC may determine the format of
this report by rule, subject to Commission approval.
---------------------------------------------------------------------------

    \685\ See discussion above in section II.C.4. of this release.
---------------------------------------------------------------------------

    Because broker-dealers are currently required to file these reports
with both the Commission and SIPC, the final rule amendment does not
result in any change to the Commission's current estimate of the hour
burden for broker-dealers to comply with this requirement under the
current PRA collection for Rule 17a-5. Although broker-dealers will
file the supplemental report on SIPC membership only with SIPC if a
SIPC rule change to implement this amendment is approved by the
Commission, as noted in the current PRA collection, the variation in
the size and complexity of broker-dealers subject to Rule 17a-5 makes
it difficult to calculate the burden of the information collection of
Rule 17a-5. Therefore, the Commission will determine whether it is
appropriate to revise the PRA estimate for Rule 17a-5 after any SIPC
rule filing is approved or after the end of the two-year sunset
provision.
    In the proposing release the Commission estimated, however, that
SIPC would incur a one-time burden associated with filing a rule change
with the Commission to implement this proposed amendment of
approximately 100 hours.\686\ The process and requirements for SIPC to
file rule changes with the Commission, however, is set out in
SIPA.\687\ Any burden on SIPC to file a rule change with the Commission
would be associated with the requirements under SIPA. Therefore, the
Commission is deleting the proposed one-time 100 hours from the final
rule amendments.
---------------------------------------------------------------------------

    \686\ See Broker-Dealer Reports, 76 FR at 37597.
    \687\ 15 U.S.C. 78ccc(e)(2). The statute generally requires that
the Board of Directors of SIPC file with the Commission a copy of
any proposed rule change accompanied by a concise general statement
of the basis and purpose of such proposed rule change. In addition,
the statute states that ``the Commission shall, upon the filing of
any proposed rule change, publish notice thereof, together with the
terms of substance of such proposed rule change or a description of
the subjects and issues involved'' and that the ``Commission shall
give interested persons an opportunity to submit written data,
views, and arguments with respect to such proposed rule change.'' 15
U.S.C. 78ccc(e)(2)(A).
---------------------------------------------------------------------------

vi. Statement Regarding Independent Public Accountant
    The Commission is amending paragraph (f)(2) of Rule 17a-5 to revise
the statement regarding identification of a broker-dealer's independent
public accountant that broker-dealers must file each year with the
Commission and their DEA (except that if the engagement is of a
continuing nature, no further filing is required).\688\ The revised
statement contains additional information that includes a
representation that the independent public accountant has undertaken to
provide a report regarding the broker-dealer's financial reports and a
report regarding the broker-dealer's compliance report or exemption
report, as applicable.\689\ In addition, the statement provided by a
clearing or carrying broker-dealer must include representations
regarding the access to its accountant requirements described
above.\690\ Therefore, all broker-dealers will generally be required to
file a new statement regarding their independent public accountant. 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.\691\
---------------------------------------------------------------------------

    \688\ See discussion above in section III. of this release.
    \689\ See Rule 17a-5(f)(2)(ii). 17 CFR 240.17a-5(f)(2)(ii).
    \690\ See Rule 17a-5(f)(2)(ii)(F) and (G).
    \691\ See Broker-Dealer Reports, 76 FR at 37596.
---------------------------------------------------------------------------

    The Commission is revising this estimate for clearing and carrying
broker-dealers, as these broker-dealers will likely need to renegotiate
their agreements with their independent public accountants. The
Commission estimates, based on staff experience, that it will take a
carrying or clearing broker-dealer approximately ten hours on a one-
time basis to renegotiate its agreement with its accountant, amend its
statement regarding its accountant, and file the new statement with the
Commission. The Commission estimates that the one-time burden for all
carrying

or clearing broker-dealers is approximately 5,130 hours \692\ and the
one-time burden for all broker-dealers that neither carry customer
accounts nor clear transactions is approximately 8,392 hours,\693\ for
a total industry-wide reporting burden of approximately 13,522 hours on
a one-time basis.
---------------------------------------------------------------------------

    \692\ 10 hours x 513 carrying or clearing broker-dealers = 5,130
hours.
    \693\ 2 hours x 4,196 non-carrying and non-clearing broker-
dealers = 8,392 hours.
---------------------------------------------------------------------------

    Finally, the Commission believes there will be postage costs
associated with sending the amended statement regarding the accountant,
which must be sent to the Commission's principal office in Washington,
DC, the regional office of the Commission for the region in which the
broker-dealer's principal place of business is located, and to its DEA.
The Commission 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.\694\
---------------------------------------------------------------------------

    \694\ 4,709 broker-dealers x $0.45 cost for first class postage
x 3 mailings = $6,357.15.
---------------------------------------------------------------------------

vii. External Costs of Engagement of Accountant
    The amendments to Rule 17a-5 retain the current requirement that
broker-dealers annually file with the Commission a financial report and
a report prepared by a PCAOB-registered accountant based on an audit of
the financial report.\695\ However, the financial report must be
audited in accordance with standards of the PCAOB, instead of in
accordance with GAAS, as previously required. The amendments also
require a broker-dealer to file with the Commission either a compliance
report or an exemption report and to obtain an independent accountant's
report based on an examination or review of those reports,
respectively.\696\
---------------------------------------------------------------------------

    \695\ See discussion above in section II.D.3. of this release.
    \696\ Id.
---------------------------------------------------------------------------

    Broker-dealers incur annual external costs associated with the PRA
burden in terms of hiring outside auditors and accountants to comply
with the requirements of Rule 17a-5. Any external costs of accountants'
reports included in the PRA collection of information for these final
rule amendments are averages across all broker-dealers. The external
PRA costs incurred by a broker-dealer to comply with the final rule
amendments will generally depend on its size and the complexity of its
business activities. Because the size and complexity of broker-dealers
varies significantly, the Commission provides estimates of the average
external cost per broker-dealer across all broker-dealers.\697\
---------------------------------------------------------------------------

    \697\ In the proposing release, these costs were included in the
Economic Analysis. The Commission is also including these costs in
the PRA amendments to more accurately reflect external costs
incurred by broker-dealers as a result of the PRA hour burdens
imposed by the final rule amendments, and in response to comments.
---------------------------------------------------------------------------

    The Commission received various comments regarding the costs of the
proposed requirements and engagement of the accountant provisions. More
specifically, the Commission received comments addressing: (1) The
costs of the change from GAAS to PCAOB standards for the financial
report; (2) the costs of the examination of the new compliance report;
and (3) the costs of the review of the new exemption report. The
comments received with respect to these three areas and the
Commission's responses are addressed in detail in each subsection
below.
a. Financial Report (Including Change From GAAS to PCAOB Standards)
    Two commenters stated that the Commission did not address the costs
associated with the change from GAAS to PCAOB standards.\698\ These
costs would affect the external costs of broker-dealers under the PRA
burden to the extent the change in standards caused an increase in
external accounting fees incurred by broker-dealers. One commenter also
stated that the Commission may need to consider the PCAOB's proposed
rules before it can make a reasonable estimate, and that transition to
PCAOB standards may require substantial revisions to audit
programs.\699\ Another commenter stated that the economic analysis was
``inconclusive'' because the PCAOB has not yet established auditing and
attestation standards for broker-dealers.\700\ In response to this
comment, the Commission estimates the costs of its rules using the best
information available to it at the time.
---------------------------------------------------------------------------

    \698\ See, e.g., McGladrey Letter; SIFMA Letter.
    \699\ See ABA Letter.
    \700\ See CAI Letter.
---------------------------------------------------------------------------

    Based on information currently available, including the proposed
PCAOB standards, the Commission does not expect that the move to PCAOB
standards for audits of broker-dealer financial reports will result in
significant one-time implementation costs or recurring annual costs.
The proposed PCAOB standards for audits of financial reports (financial
statements and supporting schedules) generally incorporate concepts and
requirements contained within GAAS, thereby minimizing the potential
costs to broker-dealer auditors of this change. As such, the Commission
is not including any additional external PRA costs related to the
change from GAAS to PCAOB auditing standards.\701\ However, in response
to the comment, the Commission will examine the effect of any final
PCAOB standards on the external costs associated with this collection
of information in subsequent extensions of this collection of
information and make any necessary cost adjustments.
---------------------------------------------------------------------------

    \701\ See section VII. of this release (discussing benefits and
costs of changing from GAAS to PCAOB auditing standards).
---------------------------------------------------------------------------

b. Compliance Report
    The Commission estimated that the incremental external cost to a
carrying broker-dealer of obtaining the independent public accountant's
report based on an examination of the proposed compliance report would
be an average incremental cost of approximately $150,000 per carrying
broker-dealer per year.\702\ The Commission is including these external
costs in this collection of information.
---------------------------------------------------------------------------

    \702\ See Broker-Dealer Reports, 76 FR at 37599.
---------------------------------------------------------------------------

    One commenter stated that the Commission underestimated the cost of
examining the compliance report.\703\ This commenter believed that the
auditing costs associated with the compliance examinations were
underestimated given that the proposing release contemplated a move
from GAAS to PCAOB auditing standards.\704\ This commenter stated that
the transition may require substantial revisions to independent public
accountant audit programs, including implementation of new auditing
techniques and processes and the associated training programs and noted
that the proposed PCAOB standards were not released until after the
publication of the proposing release.\705\ Another commenter stated
that completing both the compliance reports and exemption reports
``will require extensive collaboration between management, internal
audit, and the independent public accountants'' and that due to the
``significant increase in hours,'' the proposed amendments have ``the
potential to double the total current audit fees and have a material
impact'' on firms.\706\ These commenters did not quantify their cost
estimates in terms of dollars; nor did they provide data to support
their conclusions.
---------------------------------------------------------------------------

    \703\ See ABA Letter.
    \704\ Id.
    \705\ Id.
    \706\ See Van Kampen/Invesco Letter.
---------------------------------------------------------------------------

    As explained above in section II.D. of this release, before today's
amendments, Rule 17a-5 required a broker-dealer to

engage an independent public accountant to prepare a material
inadequacy report based on, among other things, a review of the
accounting system, internal accounting control, and procedures for
safeguarding securities of the broker-dealer, including appropriate
tests, for the period since the prior examination date. In addition,
the accountant was required to review the practices and procedures
followed by the broker-dealer in, among other things, (1) making
periodic computations of net capital and under paragraph (e) of Rule
15c3-3, (2) making quarterly securities examinations, counts,
verifications, and comparisons under Rule 17a-13, and (3) obtaining and
maintaining physical possession or control of all fully paid and excess
margin securities of customers as required by Rule 15c3-3.
    Consequently, under requirements before today's amendments relating
to a material inadequacy report that are being replaced by the
examination of the compliance report, the broker-dealer was required to
engage the independent public accountant to review the internal
controls, practices, and procedures of the broker-dealer with respect
to key elements of the financial responsibility rules.
    For these reasons, the Commission continues to believe that the
average incremental cost of $150,000 per carrying broker-dealer to
obtain the accountant's report covering the compliance report is
reasonable. Moreover, as stated above, the Commission is adopting the
proposed amendments to Rule 17a-5 with respect to the compliance report
with modifications. For example, the final rule requires a statement as
to whether the broker-dealer was in compliance with Rule 15c3-1 and
paragraph (e) of Rule 15c3-3 as of the end of the most recent fiscal
year and, if applicable, a description of any instances of non-
compliance with these rules as of the fiscal year end, rather than the
proposed assertion that the broker-dealer is in compliance with the
financial responsibility rules in all material respects and the
proposed description of any material non-compliance with the financial
responsibility rules. This reflects two changes from the proposal: (1)
Elimination of the concepts of ``material non-compliance'' and
``compliance in all material respects'' with Rule 15c3-1 and 15c3-3 for
the purposes of reporting in the compliance report; and (2) a narrowing
of these statements and description requirements from compliance with
all of the financial responsibility rules to compliance with Rule 15c3-
1 and paragraph (e) of Rule 15c3-3.
    As modified, the final rule no longer requires the independent
public accountant to evaluate whether an instance of non-compliance
with the financial responsibility rules was material. While there may
be an increase in the number of reported instances of non-compliance
than under the proposal, the independent public accountant will not be
required to determine whether an instance of non-compliance is
material. Consequently, the reporting of instances of non-compliance
(as compared to instances of material non-compliance) is not expected
to increase costs of the engagement of the accountant from those
estimated for the proposal and may decrease costs.
    In addition, the final rule has been modified from the proposal so
that the independent public accountant will not be required to examine
a broker-dealer statement that encompassed compliance with all the
financial responsibility rules. Instead, the independent public
accountant must examine a statement about compliance with Rule 15c3-1
and paragraph (e) of Rule 15c3-3. In this regard, the Commission has
not amended the requirement, which existed before today's amendments,
that the independent public accountant examine the supporting schedules
to the broker-dealer's financial statements, which contain a
computation of net capital under Rule 15c3-1 and the reserve
requirement under paragraph (e) of Rule 15c3-3.
    Given these modifications, the statements in the compliance report
concerning the broker-dealer's Internal Control Over Compliance will
likely account for the bulk of the work of the independent public
accountant and, as noted above, before today's amendments, the
independent public accountant was required to include internal control
within the scope of the audit.
    The Commission believes that the modifications to the final rule
discussed above should modestly reduce the external cost of the final
rule as compared to the cost that would have resulted from the proposed
rule. Further, elimination of the requirement that the accountant
prepare a material inadequacy report will result in some cost
savings.\707\ While these modifications to the final rule may result in
reduced costs, the Commission continues to believe that the average
estimated incremental cost of $150,000 per carrying broker-dealer,
which may be at the high end of the range of estimated costs, is
reasonable.
---------------------------------------------------------------------------

    \707\ The Commission also stated in the proposing release that
the Commission estimated that amendments to the IA Custody Rule
would impose external costs of $250,000 per investment adviser, and
that the Commission estimated that the examination of the compliance
report would incrementally cost $150,000 because the IA Custody Rule
imposed new requirements on investment advisers, and, unlike the
final rule amendments being adopted today, was not based on existing
obligations. See Broker-Dealer Reports, 76 FR at 37599. Based on
this comparison, the Commission continues to believe that the
average estimated incremental cost of $150,000 per carrying broker-
dealer is reasonable and that the changes discussed above generally
should not materially impact the cost estimate as they may, in some
cases, result in a modest reduction in burden.
---------------------------------------------------------------------------

    For these reasons, the Commission has not changed its average
estimate of the incremental cost of the accountants' reports covering
the compliance report. The Commission therefore estimates that the
average industry-wide annual external reporting incremental cost of
this requirement is approximately $43,800,000 per year ($150,000 x 292
carrying broker-dealers = $43,800,000).
c. Exemption Report
    The Commission estimated that the external cost to a non-carrying
broker-dealer of obtaining the independent public accountant's report
based on a review of the proposed exemption report would be an average
of approximately $3,000 per non-carrying broker-dealer per year, for a
total estimated annual cost associated with this proposal of
$14,256,000.\708\ The Commission did not receive any specific comments
regarding this cost estimate.
---------------------------------------------------------------------------

    \708\ See Broker-Dealer Reports, 76 FR at 37599-37600. The
Commission estimated that there were 4,752 non-carrying broker-
dealers. 4,752 x $3,000 = $14,256,000.
---------------------------------------------------------------------------

    In the proposing release, the Commission stated its belief that an
independent public accountant's review of the exemption assertion would
add an incremental cost to that incurred as a result of the annual
financial audit.\709\ As discussed above, independent public
accountants engaged by broker-dealers were required, before today's
amendments, to ``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
independent public accountant's] last examination.'' \710\
---------------------------------------------------------------------------

    \709\ Id. at 37599.
    \710\ See 17 CFR 240.17a-5(g)(2).
---------------------------------------------------------------------------

    The Commission continues to believe that $3,000 is a reasonable
estimate of the cost of obtaining the accountant's report covering the
exemption report. The Commission now estimates that

there are approximately 4,417 non-carrying broker-dealers. The
Commission therefore estimates that the total industry-wide external
annual reporting cost of this requirement is approximately $13,251,000
per year (4,417 non-carrying broker-dealers x $3,000 = $13,251,000).
d. Access to Accountant and Audit Documentation
    The amendments to Rule 17a-5 require that carrying or clearing
broker-dealers agree to allow Commission and DEA staff, if requested in
writing for purposes of an examination of the broker-dealer, to review
the work papers of the independent public accountant and to allow the
accountant to discuss its findings with the examiners.
    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 and providing them with audit documentation.\711\
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.\712\ As the
Commission now estimates that the number of carrying or clearing
broker-dealers is 513, the new estimate is approximately $641,250.\713\
---------------------------------------------------------------------------

    \711\ In the proposing release, the Commission estimated that a
broker-dealer's accountant would spend approximately 5 hours per
year speaking with Commission or DEA staff and providing them with
audit documentation.
    \712\ In the proposing release, the Commission multiplied 528
clearing and carrying broker-dealers x 5 hours x $250/hour =
$660,000.
    \713\ 513 clearing and carrying broker-dealers x $1,250 in
increased costs per clearing broker-dealer = $641,250.
---------------------------------------------------------------------------

2. Conforming and Technical Amendments to Rule 17a-11
    The Commission proposed technical amendments to Rule 17a-5 and
proposed amending paragraph (e) of Rule 17a-11 to eliminate a reference
to Rule 17a-5.\714\ The Commission stated that these changes should not
result in an additional hour burden for the Rule 17a-11 collection of
information. As discussed above in section II.F.2. of this release, in
response to a comment, paragraph (e) of Rule 17a-11, as adopted,
retains a reference to Rule 17a-5. In addition, the Commission is
adopting conforming amendments to substitute the term material weakness
as defined in paragraph (d)(3)(iii) of Rule 17a-5 for the term material
inadequacy with respect to Rule 17a-5. Specifically, the final rule
provides that whenever a broker-dealer discovers, or is notified by its
accountant under paragraph (h) of Rule 17a-5 of the existence of any
material weakness, the broker-dealer must: (1) Give notice of the
material weakness within 24 hours of the discovery or notification; and
(2) transmit a report within 48 hours of the notice stating what the
broker-dealer has done or is doing to correct the situation.\715\
---------------------------------------------------------------------------

    \714\ See Broker-Dealer Reports, 76 FR at 37597.
    \715\ See paragraph (e) of Rule 17a-11. This provision retains
references to material inadequacy with respect to Rule 17a-12.
---------------------------------------------------------------------------

    The Commission does not expect any change in the number of notices
filed per year as a result of the final amendments because the material
inadequacy notification requirement is being replaced by a material
weakness notification requirement. Therefore, the final amendments to
Rule 17a-11 should not result in a change in the current PRA burden for
Rule 17a-11. However, the Commission will take into account any changes
in the number of notices associated with this collection of information
in subsequent extensions of this collection of information and make any
necessary adjustments, as appropriate.
3. Form Custody
    As described more fully above, the amendments require that all
broker-dealers registered with the Commission file Form Custody
quarterly with their DEA. The Commission estimated that the hour burden
associated with completing and filing proposed Form Custody would be
approximately 12 hours per quarter, or 48 hours per year, on average,
for each broker-dealer.\716\
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    \716\ See Broker-Dealer Reports, 76 FR at 37597.
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    In section IV. of this release, in adopting the final amendments to
Form Custody, the Commission received one comment in response to Item 8
of Form Custody, as proposed, noting that the information sought in
Item 8 was largely the same as information collected from investment
advisers on Form ADV.\717\ As stated above in section IV. of this
release, the Commission is aware that some overlap exists between the
information collected from investment advisers on Form ADV and the
information that would be collected from broker-dealers dually-
registered as investment advisers in Item 8 of proposed Form Custody.
However, these two forms also contain a significant amount of non-
overlapping material, reflecting their different purposes and uses.
Form Custody is intended to be a single source of readily-available
information to assist Commission and DEA examiners in preparing for and
performing focused custody exams, and it is particularly important that
such information be readily available in the case of dually-registered
firms. Consequently, the Commission believes that the PRA burden for
Form Custody is reasonable in light of its intended purpose, as
discussed above in section IV. of this release. Additionally, the
commenter did not indicate disagreement with the hour burden estimate
as proposed. Therefore, the Commission is retaining the hour burden
estimate without revision.
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    \717\ See Angel Letter.
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    The Commission now estimates that there are approximately 4,709
broker-dealers that must file Form Custody. The Commission therefore
estimates that the total annual burden associated with completing and
filing Form Custody for all 4,709 broker-dealers is approximately
226,032 hours per year (4,709 broker-dealer times 4 responses per year
times 12 hours = 226,032 hours).
    One commenter stated that the estimated costs to the industry of
$69,179,670 is ``staggering,'' and that such costs would likely
indirectly be passed on to customers.\718\ The commenter did not
disagree with the PRA estimate in the proposing release; rather, the
commenter focused on size of the total estimated costs. The Commission
recognizes that the requirement to file Form Custody will increase
compliance costs for broker-dealers and, consequently, the PRA
estimates reflect these costs. The PRA hour burden estimates (and
associated internal burden costs), however, are averages across all
broker-dealers. 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. Because the size and complexity
of broker-dealers varies significantly, the Commission provides
estimates of the average cost per broker-dealer across all broker-
dealers.
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    \718\ 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.
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    For these reasons, the Commission believes the internal costs
related to the PRA for this hour burden are reasonable and, therefore,
the Commission is not adjusting the final cost estimate, except to
reflect updated data with respect to

the number of broker-dealers and compensation.\719\
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    \719\ Id.
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E. Collection of Information Is Mandatory

    The collection of information obligations imposed by the rule
amendments are mandatory for broker-dealers that are registered with
the Commission.

F. Confidentiality

    The Commission expects to receive confidential information in
connection with the proposed collections of information. Paragraph
(e)(3) of Rule 17a-5, as amended, provides that broker-dealer annual
reports filed with the Commission are not confidential, except that if
the Statement of Financial Condition is bound separately from the
balance of the annual reports, 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.\720\ However, under paragraph (c)(2)(iv) of Rule 17a-5, if there
are material weaknesses, the accountant's report on the compliance
report must be made available for customers' inspection and,
consequently, it would not be deemed confidential. In addition,
paragraph (c)(2)(i) of Rule 17a-5 requires a broker-dealer to furnish
to its customers annually a balance sheet with appropriate notes
prepared in accordance with GAAP and which must be audited if the
broker-dealer is required to file audited financial statements with the
Commission.\721\ With respect to the other information collected under
the amendments, a broker-dealer can request the confidential treatment
of the information.\722\ If such a confidential treatment request is
made, the Commission anticipates that it will keep the information
confidential to the extent permitted by law.\723\
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    \720\ See paragraph (e)(3) of Rule 17a-5.
    \721\ See 17 CFR 240.17a-5(c)(2)(i).
    \722\ See 17 CFR 200.83. Information regarding requests for
confidential treatment of information submitted to the Commission is
available at http://www.sec.gov/foia/howfo2.htm#privacy.
    \723\ See, e.g., 15 U.S.C. 78x (governing the public
availability of information obtained by the Commission); 5 U.S.C.
552 et seq.
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VII. Economic Analysis

    The Commission is sensitive to the costs and benefits of its rules.
When engaging in rulemaking that requires the Commission to consider or
determine whether an action is necessary or appropriate in the public
interest, section 3(f) of the Exchange Act requires that the Commission
consider, in addition to the protection of investors, whether the
action will promote efficiency, competition, and capital
formation.\724\ In addition, section 23(a)(2) of the Exchange Act
requires that the Commission consider the effects on competition of any
rules the Commission adopts under the Exchange Act, and prohibits the
Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.\725\
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    \724\ 15 U.S.C. 78c(f).
    \725\ 15 U.S.C. 78w(a)(2).
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    In the proposing release, the Commission solicited comment on the
costs and benefits of the proposed amendments and new form, including
whether estimates of the costs and benefits were accurate and
comprehensive.\726\ The Commission further encouraged commenters to
provide specific data and analysis in support of their views.\727\ The
Commission also requested comment on whether the proposed amendments
would place a burden on competition, and promote efficiency,
competition, and capital formation.\728\
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    \726\ See Broker-Dealer Reports, 76 FR at 37598. An economic
analysis was included in the proposing release. Id. at 37598-37601.
    \727\ Id. at 37598.
    \728\ Id.
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    The Commission received 27 comment letters on the proposed
amendments. A number of commenters addressed the Commission's estimates
of the cost and benefits of the proposed amendments.\729\ Generally,
these commenters stated that the Commission's cost and benefit
estimates failed to include all of the costs associated with the
proposed amendments and that the costs that the Commission did include
in its analysis were underestimated. For example, one commenter stated
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.\730\ While commenters stated
that the Commission underestimated costs, they did not provide
alternative quantified estimates of the costs.\731\
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    \729\ See ABA Letter; AICPA Letter; Angel Letter; CAI Letter;
Citrin Letter; IMS Letter; KPMG Letter; McGladrey Letter; SIFMA
Letter; Van Kampen/Invesco Letter.
    \730\ See IMS Letter.
    \731\ For example, one commenter stated that the Commission's
estimate of the costs of the compliance report have ``the potential
to double the total current audit fees and have a material impact''
on firms. See Van Kampen/Invesco Letter. The commenter, however, did
not provide a quantified baseline estimate of current audit fees
incurred by broker-dealers with which to compare the Commission's
estimate of the incremental cost that the compliance report
amendments will have on audit fees.
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    As discussed throughout this release, in part in response to
comments, the Commission has modified the proposed rules to reduce
compliance burdens where consistent with investor protection. In
addition, as discussed below, where commenters identified costs the
Commission did not consider, the Commission has revised its economic
analysis of the final rules to take these costs into account.
    In adopting the rule amendments and new form, the Commission has
been mindful of the associated costs and benefits. The costs and
benefits that the Commission has considered in adopting these
amendments and new form are discussed below. The discussion focuses on
the Commission's reasons for adopting these amendments and new form,
the affected parties, and the costs and benefits of the amendments and
new form compared to the baseline, described below, and to alternative
courses of action.
    Many of the benefits and costs discussed below are difficult to
quantify, in particular when discussing increases in investor
confidence and improvements in investor protection. For example, the
extent to which the increased ability of the Commission and DEAs to
oversee compliance with the financial responsibility rules will help
limit future violations of the rules is unknown. Similarly, it is
unknown how much increasing the focus of broker-dealers on the
financial responsibility rules will result in enhanced compliance with
those rules. Moreover, limited public data exists to study the costs of
broker-dealer audits. Therefore, much of the discussion is qualitative
in nature but, where possible, the Commission attempted to quantify the
costs.

A. Motivation for the Amendments

    The rule amendments and new form being adopted today are designed
to provide additional safeguards with respect to broker-dealer custody
of customer securities and funds. The motivation for these amendments,
which are discussed throughout this release, are summarized below.

    First, as mentioned above in section I.A. of this release, over the
last several years, the Commission has brought several cases alleging
fraudulent conduct by investment advisers and broker-dealers, including
among other things, alleged misappropriation or other misuse of
customer securities and funds.\732\ These cases highlight the need for
enhancements to the rules governing broker-dealer custody of customer
assets. Such enhancements include both increased focus on compliance
and internal compliance controls by broker-dealers and their auditors,
as well as measures to increase the ability of the Commission and
broker-dealer DEAs to oversee broker-dealer custody practices by
requiring broker-dealers to provide more information about these
practices.
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    \732\ See, e.g., SEC v. Donald Anthony Walker Young, et al.,
Litigation Release No. 21006 (Apr. 20, 2009); SEC v. Isaac I. Ovid,
et al., Litigation Release No. 20998 (Apr. 14, 2009); SEC v. The
Nutmeg Group, LLC, et al., Litigation Release No. 20972 (Mar. 25,
2009); SEC v. WG Trading Investors, L.P., et al., Litigation Release
No. 20912 (Feb. 25, 2009); SEC v. Stanford International Bank, et
al., Litigation Release No. 20901 (Feb. 17, 2009); SEC v. Bernard L.
Madoff, et al., Litigation Release No. 20889 (Feb. 9, 2009). The
Commission also has brought an enforcement action against an
accountant that purported to audit financial statements and
disclosures of one of these broker-dealers. See SEC v. David G.
Friehling, C.P.A., et al., Litigation Release No. 20959 (Mar. 18,
2009).
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    Second, as discussed above in section II.D. of this release,
certain provisions of Rule 17a-5 before today's amendments were
inconsistent with current audit practices, standards, and terminology,
which have evolved since these provisions were adopted. This
inconsistency has resulted in disparate audit practices and
inconsistent compliance with the rule. As discussed above in section
II.D.3.iii. of this release, the PCAOB has published a report
containing observations from inspections of portions of 23 broker-
dealer audits conducted by ten accounting firms.\733\ According to the
report, PCAOB inspections staff identified deficiencies in all of the
audits inspected.\734\ The deficiencies noted in the report provide
support for the need to strengthen and clarify broker-dealer audit and
reporting requirements in order to facilitate consistent compliance
with these requirements.
---------------------------------------------------------------------------

    \733\ See PCAOB Inspection Report at p. ii.
    \734\ Id.
---------------------------------------------------------------------------

    Third, as discussed in section II.D. of this release, prior to
today's amendments, Rule 17a-5 required that broker-dealer audits be
conducted in accordance with GAAS, which are established by the
Auditing Standards Board of the AICPA. The amendments--by requiring
that the audits be conducted in accordance with PCAOB standards--
recognize the PCAOB's explicit oversight authority over broker-dealer
audits as provided by the Dodd-Frank Act, including the authority to
establish (subject to Commission approval) and enforce auditing and
related attestation, quality control, ethics, and independence
standards.\735\ In addition, the Commission has direct oversight
authority over the PCAOB, including the authority to approve or
disapprove the PCAOB's rules and standards.\736\ Consequently,
requiring that broker-dealer audits be conducted in accordance with
standards the Commission has approved will better ensure alignment
between broker-dealer audits and the regulatory policy objectives
reflected in the Commission's financial responsibility rules.
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    \735\ See discussion in section II.D.3. of this release.
    \736\ Section 107(a) of the Sarbanes-Oxley Act provides that the
Commission ``shall have oversight and enforcement authority over the
[PCAOB] as provided by the [Sarbanes-Oxley Act].'' Section 107(b) of
the Sarbanes-Oxley act provides that ``[n]o rule of the [PCAOB]
shall become effective without prior approval of the Commission''
other than certain initial or transitional standards. Section 107(c)
of the Sarbanes-Oxley Act provides for Commission review of
disciplinary action taken by the PCAOB. Section 107(d) of the
Sarbanes-Oxley Act provides that the Commission may censure and
impose other sanctions on the PCAOB in certain circumstances.
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    Fourth, as discussed in section II.B.6. of this release, because
broker-dealers have not been required to file with SIPC their annual
audited financial statements, SIPC has received limited information
regarding the financial condition of its broker-dealer members. SIPC
can use this information, among other things, to assess whether the
SIPC Fund is appropriately sized to the risks of a large broker-dealer
failure. In addition, at least one court, the New York Court of
Appeals, has held that in cases where SIPC is required to fund the
liquidation of a broker-dealer, SIPC could not maintain a claim against
the auditor of the broker-dealer based on an alleged failure to comply
with auditing standards because SIPC did not receive the audited
financial statements and therefore could not have relied upon them.
    Fifth, as discussed in section III. of this release, the audit work
performed by independent public accountants with respect to audits of
carrying and clearing broker-dealers can provide useful information to
Commission and DEA examiners in terms of planning the scope and focus
of the examination of the broker-dealer. Providing Commission and DEA
examiners with access to the independent public accountant that audited
the broker-dealer and audit documentation related to the audit will
allow the examiners to gain an understanding of the work the accountant
did in auditing the broker-dealer and any areas of concern highlighted
by the auditor. This will enable the examiners to conduct risk-based
examinations of carrying and clearing broker-dealers and assist the
examiners in determining areas of focus for their examinations.
Furthermore, the amendments will make it clear to the independent
public accountant that the broker-dealer has agreed that the accountant
can provide this information and, consequently, eliminate uncertainty
as to whether the broker-dealer consents to the disclosure of the
information.
    Sixth, as discussed in section IV. of this release, because broker-
dealers were not required to provide comprehensive or consolidated
information about their custody practices to the Commission or their
DEA, the Commission and the broker-dealer's DEA had a fragmented and
incomplete picture of whether a broker-dealer maintained custody of
customer and non-customer assets, and if so, how such assets were
maintained. This hindered the ability of the Commission and DEAs to
efficiently plan, prioritize, and perform examinations.

B. Economic Baseline

    The regulatory changes adopted today amend requirements that apply
to broker-dealers registered with the Commission and independent public
accountants that audit or attest to broker-dealer annual reports. The
discussion below includes approximate numbers of broker-dealers and
accountants that would be affected by today's amendments and a
description of the economic baseline against which the costs and
benefits, as well as the impact on efficiency, competition, and capital
formation, of today's amendments and new form are measured.
1. Broker-Dealers
    The broker-dealers registered with the Commission vary
significantly in terms of their size, business activities, and the
complexity of their operations. For example, carrying broker-dealers
hold customer securities and funds.\737\

Clearing broker-dealers clear transactions as members of security
exchanges and the Depository Trust & Clearing Corporation and the
Options Clearing Corporation.\738\ Many clearing broker-dealers are