The Public Company Accounting Oversight Board voted Tuesday to adopt rules to implement provisions of last year’s financial reform bill to begin inspecting auditors of securities brokers and dealers.
The PCAOB decided to adopt a temporary rule to establish an interim inspection program for registered public accounting firms' audits of brokers and dealers. The board also adopted rules for assessing and collecting a portion of its accounting support fee from brokers and dealers to fund PCAOB oversight of audits of brokers and dealers, consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act. In addition, the PCAOB adopted certain amendments to its existing funding rules for issuers.
“The board’s actions today are an important step in oversight of the audits of brokers and dealers,” said PCAOB Chairman James R. Doty. “The interim inspection program will allow the board to gain a better understanding of how PCAOB can provide meaningful investor protection, consistent with our intent to avoid imposing unnecessary burdens on smaller auditors and broker-dealers. And I believe the amendments to the board’s funding rules provide an efficient mechanism to fund the PCAOB’s oversight without imposing unwarranted costs and administrative burdens on smaller brokers and dealers.”
The Dodd-Frank Act authorized the board to establish, by rule, a program of inspection of auditors of brokers and dealers. The law leaves to the board, subject to the approval of the Securities and Exchange Commission, important questions concerning the scope of the program and the frequency of inspections, including whether to differentiate among categories of brokers and dealers and whether to exclude from the inspection program any categories of auditors.
The temporary rule adopted by the board on Tuesday provides for an interim inspection program while the board considers the scope and other elements of a permanent inspection program.
Under the temporary rule, the PCAOB will begin to inspect auditors of brokers and dealers and identify and address with the registered firms any significant issues in those audits.
The board also expects that insights gained through the interim program will inform the eventual determination of the scope and elements of a permanent program, and the board expects to propose rules governing the scope and elements of a permanent program in 2013.
The American Institute of CPAs, and some members of Congress, had written to the PCAOB asking to exempt firms that audit “introducing broker-dealers” as opposed to “clearing, carrying and custodial broker dealers,” who are more likely to handle client funds (see Congress Questions PCAOB Broker-Dealer Audit Rule). However, the PCAOB decided to inspect the auditors of the introducing broker-dealers for now under the temporary program.
“One of the most critical [issues] is whether or not the permanent program should apply to all brokerage firm audits,” said board member Daniel Goelzer. “There are about 5,000 broker-dealers. However, only 520 or so provide clearing or custodial services. Many of the others are introducing firms that, at least in theory, do not have access to client funds or securities.” He added that because of the lower risk of investor harm, he believes that the board will ultimately conclude that auditors of some classes of brokerage firms should be exempt from PCAOB oversight. “I also believe, however, that the best way to make that decision is on the basis of the type of factual information that can most effectively be collected during the interim inspection program,” said Goelzer.
During the interim program, the board will provide public reports on the progress of the interim program and significant issues identified. In the absence of unusual circumstances, however, the board will not issue firm-specific inspection reports before inspection work is performed under the permanent program and will not issue firm-specific inspection reports on any firms that are eventually excluded from the scope of the permanent program.
The temporary rule does not change anything about the rules or standards that govern audits of broker-dealers. As the SEC has previously explained, its rules continue to require those audits to be carried out under generally accepted auditing standards.
Section 109 of the Sarbanes-Oxley Act, as originally enacted, provided that funds to cover the PCAOB annual budget, less registration and annual fees paid by registered public accounting firms, would be collected from issuers based on each issuer's relative average monthly equity market capitalization. The amount due from issuers is referred to as the accounting support fee.
As amended by the Dodd-Frank Act, Section 109 now requires that the PCAOB allocate respective portions of its total accounting support fee among issuers and brokers and dealers, and allows for differentiation among classes of brokers and dealers.
The funding rules adopted Tuesday, which are subject to approval by the SEC, would result in brokers and dealers with more than $5 million in tentative net capital being allocated an appropriate portion of the accounting support fee. The PCAOB said it anticipates that the rules will be in effect for its 2011 funding cycle for broker and dealers, which begins in the fall.
The PCAOB also adopted amendments to its funding rules for issuers, based on its experience with the accounting support fee process for issuers since 2003. The amendments, among other things, increase the market capitalization threshold for equity issuers from $25 million to $75 million and investment company issuers from $250 million to $500 million and revise the basis for calculating an issuer's market capitalization to include the market capitalization of all classes of an issuers' voting and non-voting common equity rather than just its common stock. The board anticipates that the rules related to the accounting support fee for issuers, subject to SEC approval, would become effective for its 2012 funding cycle for issuers.
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