[House Report 115-1075]
[From the U.S. Government Publishing Office]
115th Congress } { Report
HOUSE OF REPRESENTATIVES
2d Session } { 115-1075
======================================================================
SMALL BUSINESS AUDIT CORRECTION ACT OF 2018
_______
December 12, 2018.--Committed to the Committee of the Whole House on
the State of the Union and ordered to be printed
_______
Mr. Hensarling, from the Committee on Financial Services, submitted the
following
R E P O R T
together with
MINORITY VIEWS
[To accompany H.R. 6021]
[Including cost estimate of the Congressional Budget Office]
The Committee on Financial Services, to whom was referred
the bill (H.R. 6021) to amend the Sarbanes-Oxley Act of 2002 to
exclude privately held, non-custody brokers and dealers that
are in good standing from certain requirements under title I of
that Act, and for other purposes, having considered the same,
report favorably thereon with amendments and recommend that the
bill as amended do pass.
The amendments are as follows:
Strike all after the enacting clause and insert the
following:
SECTION 1. SHORT TITLE.
This Act may be cited as the ``Small Business Audit Correction Act of
2018''.
SEC. 2. EXEMPTION.
(a) Amendments to Title I of the Sarbanes-Oxley Act of 2002.--Section
110 of the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7220) is amended--
(1) in paragraph (3), by inserting ``, except that the term
does not include a non-custody broker or dealer that is
privately held and in good standing'' after ``registered public
accounting firm'';
(2) in paragraph (4), by inserting ``, except that the term
does not include a non-custody broker or dealer that is
privately held and in good standing'' after ``registered public
accounting firm'';
(3) by redesignating paragraphs (5) and (6) as paragraphs (8)
and (9), respectively; and
(4) by inserting after paragraph (4) the following:
``(5) In good standing.--The term `in good standing' means,
with respect to a broker or dealer (as those terms are defined
in section 3(a) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a))), that, as of the last day of the most recently
completed fiscal year of the broker or dealer, as applicable,
the broker or dealer--
``(A) was registered with the Commission;
``(B) was a member of a registered securities
association (as defined under section 15A of the
Securities Exchange Act of 1934 (15 U.S.C. 78o-3));
``(C) was compliant with the minimum dollar net
capital requirements under section 240.15c3-1 of title
17, Code of Federal Regulations, or any successor
regulation;
``(D) had not, during the 10-year period preceding
that date, been convicted of a felony under Federal or
State law;
``(E) does not have an associated person (as that
term is defined in section 3(a) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a))) who, during
the 10-year period preceding that date, was convicted
of a felony under Federal or State laws for fraudulent
conduct; and
``(F) was not, as provided by section 3(a)(39) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a))--
``(i) expelled or suspended from membership
or participation in any self-regulatory
organization (as provided in section 3(a)(26)
of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(26))) or a registered futures
association (as provided in section 17 of the
Commodity Exchange Act (7 U.S.C. 21));
``(ii) subject to an order of the Commission,
or other appropriate regulatory agency,
denying, suspending, or revoking its
registration as any regulated entity; or
``(iii) subject to an order of the Commodity
Futures Trading Commission, or other
appropriate regulatory agency, denying,
suspending, or revoking its registration under
the Commodity Exchange Act (7 U.S.C. 1 et seq.)
or its authority to engage in any transactions.
``(6) Non-custody broker or dealer.--The term `non-custody
broker or dealer' means a broker or dealer (as those terms are
defined in section 3(a) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a))), as applicable, that--
``(A) as of the last day of the most recently
completed fiscal year of the broker or dealer had not
less than 1 and not more than 150 associated persons
(as that term is defined in section 3(a) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)))
registered with a self-regulatory organization (as
provided in section 3(a)(26) of the Securities Exchange
Act (15 U.S.C. 78c(a)(26))) of which the broker or
dealer is a member; and
``(B) throughout the most recently completed fiscal
year of the broker or dealer--
``(i) did not, as a matter of ordinary
business practice in connection with the
activities of the broker or dealer, receive
customer checks, drafts, or other evidence of
indebtedness made payable to the broker or
dealer;
``(ii) promptly forwarded customer securities
and customer checks, drafts, or other evidence
of indebtedness payable to a third party,
including a clearing broker or dealer, in
compliance with section 240.15c3-3 of title 17,
Code of Federal Regulations, or any successor
regulation;
``(iii) did not otherwise hold customer
securities or cash;
``(iv) if required under section 3(a)(2) of
the Securities Investor Protection Act of 1970
(15 U.S.C. 78ccc(a)(2)), was a member of the
Securities Investor Protection Corporation; and
``(v) either--
``(I) claimed exemption from section
240.15c3-3 of title 17, Code of Federal
Regulations, or any successor
regulation; or
``(II) claimed no exemption from such
section 240.15c3-3, or any successor
regulation, or was not otherwise
subject to such, because the broker or
dealer did not maintain custody over
any customer securities or cash.
``(7) Privately held.--The term `privately held' means, with
respect to a broker or dealer (as those terms are defined in
section 3(a) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a))), that the broker or dealer, as applicable, is not an
issuer.''.
(b) Amendments to Regulations.--Not later than 180 days after the
date of enactment of this Act, the Securities and Exchange Commission
shall make any necessary amendments to regulations of the Commission
that are in effect as of the date of enactment of this Act in order
to--
(1) carry out this Act and the amendments made by this Act;
and
(2) to exclude the auditors of non-custody brokers and
dealers that are privately held and in good standing (as such
terms are defined under section 110 of the Sarbanes-Oxley Act
of 2002) from the audit requirements of the Public Company
Accounting Oversight Board.
(c) Effective Date.--This Act, and the amendments made by this Act,
shall take effect on the date that is 180 days after the date of
enactment of this Act.
Amend the title so as to read:
A bill to amend the Sarbanes-Oxley Act of 2002 to exclude
the audits of privately held, non-custody brokers and dealers
that are in good standing from certain requirements under title
I of that Act, and for other purposes.
Purpose and Summary
Current regulations require all brokers and dealers--
irrespective of whether they are public companies, large or
small, or take custody of client funds or securities--to hire a
Public Company Accounting Oversight Board or PCAOB-registered
audit firm to conduct audits and be subject to the PCAOB's
registration, inspection, rule-making and enforcement regime.
To limit the applicability of these regulations, on June 6,
2018, Representative French Hill introduced H.R. 6021, the
``Small Business Audit Correction Act of 2018'' to provide a
narrowly tailored exception for privately-held, small
noncustodial brokers and dealers in good standing from the
requirement to hire a PCAOB-registered audit firm in order to
meet the annual Securities Exchange Act Rule 17a-5 reporting
obligation.
Background and Need for Legislation
The goal of H.R. 6021 is to eliminate unnecessarily
burdensome one-size-fits-all PCAOB regulatory requirements that
have been placed on small, privately-held brokers and dealers
that do not take custody of client funds or securities.
Current regulations require all investment brokers and
dealers to hire a PCAOB-registered audit firm to conduct audits
using more complex guidelines that were designed--consistent
with the ``Public Company'' in PCAOB--for larger, public
companies. PCAOB audit requirements may make sense for public
companies with shareholders and those brokers and dealers that
maintain custody over customer funds or securities, as there is
greater risk to the public markets, but they do not make sense
for small, privately-held, noncustodial brokers and dealers--
many of whom find it too burdensome to operate under the PCAOB
regime.
Title I of the Sarbanes-Oxley Act of 2002 (Pub. L. 107-204)
created the PCAOB to oversee the audits of U.S. public
companies in the wake of massive accounting failures at Enron
and other large companies such as WorldCom, Global Crossing,
Adelphia, Tyco, and HealthSouth. Following the exposure of the
Bernie Madoff Ponzi Scheme in late 2008, Subtitle I of Title IX
of the Dodd-Frank Act, specifically Section 982, expanded the
PCAOB's jurisdiction to apply to auditors of broker-dealers.
Although auditors of broker-dealers that also were public
companies, such as bank subsidiaries, were already subject to
PCAOB regulation prior to Dodd-Frank; that legislation added
new requirements for auditors of small- and medium-sized
brokers and dealers to be subject to the PCAOB's regulatory
regime. The result of Section 982 of the Dodd-Frank Act is a
disproportionate and burdensome regulatory obligation imposed
on small- and medium-sized brokers and dealers and an auditing
regime that does not properly account for the business model of
brokers and dealers who are small, privately-held, and
noncustodial.
In 2011, the PCAOB implemented an interim inspection
program to gather information on all broker-dealers to develop
a permanent audit program. The PCAOB released its first
progress report in August 2012, noting deficiencies in all 23
broker-dealer audits it inspected, which were performed under
AICPA standards rather than those of the PCAOB. Following the
release of this first report, the Securities and Exchange
Commission amended Rule 17a-5 to require that audits of broker-
dealers be conducted in accordance with PCAOB, rather than
AICPA, standards. AICPA standards employ Generally Accepted
Auditing Standards (GAAP), which are generally accepted
practice among auditors, whereas PCAOB standards are
requirements promulgated by a regulator. In addition, the PCAOB
inspection process is more rigorous than the AICPA peer-review
process.
Under this regime, a registered public accounting firm must
certify financial statements for broker-dealers. The accounting
firm must cooperate with PCAOB inspection or enforcement
processes and must comply with PCAOB annual and special
reporting rules. Additionally, registered public accounting
firms must follow auditing and attestation, quality control,
ethics, and independence standards regarding audit reports for
broker-dealers. For non-public broker-dealers, many of whom do
not have an audit committee, these new responsibilities to
understand applicable financial reporting requirements and
audit standards falls on management to ensure compliance.
PCAOB audit standards designed and priced for larger public
companies disproportionately affect privately-held small
businesses. In 2016, there were 783 PCAOB-registered audit
firms. But in 2017, there were only 478--a nearly 40% reduction
in the number of firms eligible to audit public companies and
the approximately 3,700 broker-dealers around the country. It
should not be a surprise that with a decreasing number of audit
firms, smaller broker-dealers are experiencing audit cost
increases. Small broker-dealers, on average, employ twenty
people or less and are much smaller organizations as compared
to the larger, public companies for which the PCAOB developed
these standards.
According to a small-firm survey conducted in 2017 by the
Small Firm Advisory Board of the Financial Institution
Regulatory Authority (FINRA), the average time spent on audits
nearly doubled and average audit costs are up sharply for small
firms in all revenue classes since the full implementation of
the PCAOB auditing requirements. The survey found that the
average increase in the cost of annual audits had jumped 83%--a
jump, on average, from $10,228 to $18,710. If that amount is
multiplied across the 3,339 small firms that existed as of May
21, 2018, the cumulative additional cost totals more than $28.3
million. This is $28.3 million that could be invested into
technology advancements to protect customer data and
information, enhancements to the way small firms can better
serve their customers, and job and capital creation--not to
mention the staff productivity that could be focused on such
issues. After all, the total number of man-hours that small
firms report their staff spending to complete the firm's audit
almost doubled from 44 hours to 82 hours.
Opponents of this legislation fallback on two misleading
headlines. First, they claim that the deficiency rate on
auditing firms reported in the PCAOB's annual report on its
Interim Program indicates that the PCAOB audit standards for
all broker-dealers are important to maintain to ensure
effective auditing and to protect broker-dealer customers and
investors. Unfortunately, such an argument stops before
actually considering the inputs and the regulatory framework at
issue. In particular, the deficiency rate in the PCAOB's report
is focused on the work of the auditors and not the reliability
of the brokers or dealers who shoulder the cost of those
audits. After all, the PCAOB's job is to make sure auditors are
performing audits in accordance with PCAOB standards. In other
words, the deficiencies reported relate to whether certain
audit principles were followed properly and do not mean that
the broker-dealers' financial statements or supporting
materials are materially misstated. To be clear, the PCAOB
report has been issued for four-years running, and each year
the PCAOB reports deficiencies of 90+%. Such a four-year trend
begs the question of why either the PCAOB or SEC have not taken
action if such a rate truly is harming investors. The most
logical answer is that those writing the report know themselves
that the standards do not fit and never will, and they know the
vast majority of the ``deficiencies''' would not and do not
affect the overall audit opinion. The findings of the report
and the absence of any urgency to reduce the deficiency rate
the past four years actually underscores that deficiencies can
be expected when you make public company standards one-size-
fits-all and apply them to audits of nonpublic companies, which
do not present the same risk to investors when they are
noncustodial and which often traditionally have been done by
auditors who do not audit public companies.
Second, opponents also have falsely claimed that H.R. 6021
will result in a void of oversight of small, privately-held,
noncustodial broker-dealers. This simply is false, as it
ignores the fact that PCAOB oversight of these firms is
duplicative and unnecessary. FINRA and the SEC test for
compliance with Federal securities laws, Self-Regulatory
Organization rules, and compliance with the broker-dealers'
written supervisory procedures. All of these examinations
already provide protection for customers whose broker-dealers
are noncustodial. Further, FINRA broker-dealers are examined or
audited by state securities regulators in the states where they
are registered, the SEC, the Commodity Futures Trading
Commission (if the entity is registered with the CFTC), the
National Futures Association, and the Internal Revenue Service
for compliance with the Employee Retirement Income Security Act
of 1974.
In short, the PCAOB's one-size-fits-all approach is
inappropriate and unnecessarily burdensome for small, privately
held noncustodial brokers and dealers--those firms that do not
take custody of client assets. H.R. 6021 addresses this problem
by narrowly tailoring a legislative exception for privately-
held, small noncustodial brokers and dealers in good standing
from the requirement to hire a PCAOB-registered audit firm in
order to meet the annual SEC Rule 17a-5 reporting obligation.
Hearings
The Committee on Financial Services held no hearings
examining matters relating to H.R. 6021.
Committee Consideration
The Committee on Financial Services met in open session on
September 13, 2018, and ordered H.R. 6021 to be reported
favorably to the House as amended by a recorded vote of 36 yeas
to 16 nays (recorded vote no. FC-213), a quorum being present.
An amendment in the nature of a substitute offered by
Representative Hill was agreed to by voice vote.
Committee Votes
Clause 3(b) of rule XIII of the Rules of the House of
Representatives requires the Committee to list the record votes
on the motion to report legislation and amendments thereto. The
sole recorded vote was on a motion by Chairman Hensarling to
report the bill favorably to the House as amended. The motion
was agreed to by a recorded vote of 36 yeas to 16 nays (Record
vote no. FC-213), a quorum being present.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Committee Oversight Findings
Pursuant to clause 3(c)(1) of rule XIII of the Rules of the
House of Representatives, the findings and recommendations of
the Committee based on oversight activities under clause
2(b)(1) of rule X of the Rules of the House of Representatives,
are incorporated in the descriptive portions of this report.
Performance Goals and Objectives
Pursuant to clause 3(c)(4) of rule XIII of the Rules of the
House of Representatives, the Committee states that H.R. 6021
will reduce the disproportionate regulatory burden on privately
held, small non-custodial broker-dealer firms by exempting them
from the requirement to hire a PCAOB-registered audit firm to
meet certain reporting requirements.
New Budget Authority, Entitlement Authority, and Tax Expenditures
In compliance with clause 3(c)(2) of rule XIII of the Rules
of the House of Representatives, the Committee adopts as its
own the estimate of new budget authority, entitlement
authority, or tax expenditures or revenues contained in the
cost estimate prepared by the Director of the Congressional
Budget Office pursuant to section 402 of the Congressional
Budget Act of 1974.
Congressional Budget Office Estimates
Pursuant to clause 3(c)(3) of rule XIII of the Rules of the
House of Representatives, the following is the cost estimate
provided by the Congressional Budget Office pursuant to section
402 of the Congressional Budget Act of 1974:
U.S. Congress,
Congressional Budget Office,
Washington, DC, November 19, 2018.
Hon. Jeb Hensarling,
Chairman, Committee on Financial Services,
House of Representatives, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for H.R. 6021, the Small
Business Audit Correction Act of 2018.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contact is Stephen
Rabent.
Sincerely,
Keith Hall,
Director.
Enclosure.
H.R. 6021--Small Business Audit Correction Act of 2018
Under current law, securities issuers, brokers, and dealers
that are registered with the Securities and Exchange Commission
(SEC) must be audited by an accounting firm that is registered
with the Public Company Accounting Oversight Board (PCAOB) and
must follow certain rules and requirements when preparing audit
reports. H.R. 6021 would exempt from the PCAOB's definition of
broker or dealer certain privately held brokers or dealers that
meet other requirements, allowing those brokers or dealers to
be audited by a firm that is not registered with the PCAOB.
Using information from the SEC, CBO estimates that
implementing H.R. 6021 would cost less than $500,000 for the
agency to amend its rules. However, the SEC is authorized to
collect fees sufficient to offset its annual appropriation;
therefore, CBO estimates that the net effect on discretionary
spending would be negligible, assuming appropriation actions
consistent with that authority.
Using information from the PCAOB, CBO estimates that
implementing H.R. 6021 would increase direct spending by less
than $500,000 to make changes to PCAOB regulations. However,
the PCAOB is authorized to assess fees (which are recorded in
the budget as revenues) to offset its operation costs.
Therefore, CBO expects that the net effect on the deficit would
be negligible. Because enacting the bill would affect direct
spending and revenues, pay-as-you-go procedures apply.
CBO estimates that enacting H.R. 6021 would not
significantly increase net direct spending or on-budget
deficits in any of the four consecutive 10-year periods
beginning in 2029.
H.R. 6021 contains no intergovernmental mandates as defined
in the Unfunded Mandates Reform Act (UMRA).
If the SEC and the PCAOB increased fees to offset the costs
associated with implementing the bill, H.R. 6021 would increase
the cost of an existing mandate on private entities required to
pay those assessments and fees. CBO estimates that the
incremental cost of the mandate would be less than $1 million,
well below the annual threshold for private-sector mandates
established in UMRA ($160 million in 2018, adjusted annually
for inflation).
The CBO staff contacts for this estimate are Stephen Rabent
(for federal costs) and Rachel Austin (for mandates). The
estimate was reviewed by H. Samuel Papenfuss, Deputy Assistant
Director for Budget Analysis.
Federal Mandates Statement
This information is provided in accordance with section 423
of the Unfunded Mandates Reform Act of 1995.
The Committee has determined that the bill does not contain
Federal mandates on the private sector. The Committee has
determined that the bill does not impose a Federal
intergovernmental mandate on State, local, or tribal
governments.
Advisory Committee Statement
No advisory committees within the meaning of section 5(b)
of the Federal Advisory Committee Act were created by this
legislation.
Applicability to Legislative Branch
The Committee finds that the legislation does not relate to
the terms and conditions of employment or access to public
services or accommodations within the meaning of the section
102(b)(3) of the Congressional Accountability Act.
Earmark Identification
With respect to clause 9 of rule XXI of the Rules of the
House of Representatives, the Committee has carefully reviewed
the provisions of the bill and states that the provisions of
the bill do not contain any congressional earmarks, limited tax
benefits, or limited tariff benefits within the meaning of the
rule.
Duplication of Federal Programs
In compliance with clause 3(c)(5) of rule XIII of the Rules
of the House of Representatives, the Committee states that no
provision of the bill establishes or reauthorizes: (1) a
program of the Federal Government known to be duplicative of
another Federal program; (2) a program included in any report
from the Government Accountability Office to Congress pursuant
to section 21 of Public Law 111-139; or (3) a program related
to a program identified in the most recent Catalog of Federal
Domestic Assistance, published pursuant to the Federal Program
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No.
98-169).
Disclosure of Directed Rulemaking
Pursuant to section 3(i) of H. Res. 5, (115th Congress),
the following statement is made concerning directed rule
makings: The Committee estimates that the bill requires no
directed rule makings within the meaning of such section.
Section-by-Section Analysis of the Legislation
Section 1. Short title
This section cites H.R. 6021 as the ``Small Business Audit
Correction Act of 2018''.
Section 2. Exemption
This section amends the Sarbanes-Oxley Act of 2002 to
exempt privately-held, non-custodial brokers and dealers in
good standing from the requirement to hire a PCAOB registered
audit firm in order to meet the annual Securities Exchange Act
Rule 17a-5 reporting obligation.
Changes in Existing Law Made by the Bill, as Reported
In compliance with clause 3(e) of rule XIII of the Rules of
the House of Representatives, changes in existing law made by
the bill, as reported, are shown as follows (existing law
proposed to be omitted is enclosed in black brackets, new
matter is printed in italic, and existing law in which no
change is proposed is shown in roman):
SARBANES-OXLEY ACT OF 2002
* * * * * * *
TITLE I--PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD
* * * * * * *
SEC. 110. DEFINITIONS.
For the purposes of this title, the following definitions
shall apply:
(1) Audit.--The term ``audit'' means an examination
of the financial statements, reports, documents,
procedures, controls, or notices of any issuer, broker,
or dealer by an independent public accounting firm in
accordance with the rules of the Board or the
Commission, for the purpose of expressing an opinion on
the financial statements or providing an audit report.
(2) Audit report.--The term ``audit report'' means
a document, report, notice, or other record--
(A) prepared following an audit performed
for purposes of compliance by an issuer,
broker, or dealer with the requirements of the
securities laws; and
(B) in which a public accounting firm
either--
(i) sets forth the opinion of that
firm regarding a financial statement,
report, notice, or other document,
procedures, or controls; or
(ii) asserts that no such opinion
can be expressed.
(3) Broker.--The term ``broker'' means a broker (as
such term is defined in section 3(a)(4) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)))
that is required to file a balance sheet, income
statement, or other financial statement under section
17(e)(1)(A) of such Act (15 U.S.C. 78q(e)(1)(A)), where
such balance sheet, income statement, or financial
statement is required to be certified by a registered
public accounting firm, except that the term does not
include a non-custody broker or dealer that is
privately held and in good standing.
(4) Dealer.--The term ``dealer'' means a dealer (as
such term is defined in section 3(a)(5) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(5)))
that is required to file a balance sheet, income
statement, or other financial statement under section
17(e)(1)(A) of such Act (15 U.S.C. 78q(e)(1)(A)), where
such balance sheet, income statement, or financial
statement is required to be certified by a registered
public accounting firm, except that the term does not
include a non-custody broker or dealer that is
privately held and in good standing.
(5) In good standing.--The term ``in good
standing'' means, with respect to a broker or dealer
(as those terms are defined in section 3(a) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a))),
that, as of the last day of the most recently completed
fiscal year of the broker or dealer, as applicable, the
broker or dealer--
(A) was registered with the Commission;
(B) was a member of a registered securities
association (as defined under section 15A of
the Securities Exchange Act of 1934 (15 U.S.C.
78o-3));
(C) was compliant with the minimum dollar
net capital requirements under section
240.15c3-1 of title 17, Code of Federal
Regulations, or any successor regulation;
(D) had not, during the 10-year period
preceding that date, been convicted of a felony
under Federal or State law;
(E) does not have an associated person (as
that term is defined in section 3(a) of the
Securities Exchange Act of 1934 (15 U.S.C.
78c(a))) who, during the 10-year period
preceding that date, was convicted of a felony
under Federal or State laws for fraudulent
conduct; and
(F) was not, as provided by section
3(a)(39) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a))--
(i) expelled or suspended from
membership or participation in any
self-regulatory organization (as
provided in section 3(a)(26) of the
Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(26))) or a registered
futures association (as provided in
section 17 of the Commodity Exchange
Act (7 U.S.C. 21));
(ii) subject to an order of the
Commission, or other appropriate
regulatory agency, denying, suspending,
or revoking its registration as any
regulated entity; or
(iii) subject to an order of the
Commodity Futures Trading Commission,
or other appropriate regulatory agency,
denying, suspending, or revoking its
registration under the Commodity
Exchange Act (7 U.S.C. 1 et seq.) or
its authority to engage in any
transactions.
(6) Non-custody broker or dealer.--The term ``non-
custody broker or dealer'' means a broker or dealer (as
those terms are defined in section 3(a) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a))), as
applicable, that--
(A) as of the last day of the most recently
completed fiscal year of the broker or dealer
had not less than 1 and not more than 150
associated persons (as that term is defined in
section 3(a) of the Securities Exchange Act of
1934 (15 U.S.C. 78c(a))) registered with a
self-regulatory organization (as provided in
section 3(a)(26) of the Securities Exchange Act
(15 U.S.C. 78c(a)(26))) of which the broker or
dealer is a member; and
(B) throughout the most recently completed
fiscal year of the broker or dealer--
(i) did not, as a matter of
ordinary business practice in
connection with the activities of the
broker or dealer, receive customer
checks, drafts, or other evidence of
indebtedness made payable to the broker
or dealer;
(ii) promptly forwarded customer
securities and customer checks, drafts,
or other evidence of indebtedness
payable to a third party, including a
clearing broker or dealer, in
compliance with section 240.15c3-3 of
title 17, Code of Federal Regulations,
or any successor regulation;
(iii) did not otherwise hold
customer securities or cash;
(iv) if required under section
3(a)(2) of the Securities Investor
Protection Act of 1970 (15 U.S.C.
78ccc(a)(2)), was a member of the
Securities Investor Protection
Corporation; and
(v) either--
(I) claimed exemption from
section 240.15c3-3 of title 17,
Code of Federal Regulations, or
any successor regulation; or
(II) claimed no exemption
from such section 240.15c3-3,
or any successor regulation, or
was not otherwise subject to
such, because the broker or
dealer did not maintain custody
over any customer securities or
cash.
(7) Privately held.--The term ``privately held''
means, with respect to a broker or dealer (as those
terms are defined in section 3(a) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a))), that the
broker or dealer, as applicable, is not an issuer.
[(5)] (8) Professional standards.--The term
``professional standards'' means--
(A) accounting principles that are--
(i) established by the standard
setting body described in section 19(b)
of the Securities Act of 1933, as
amended by this Act, or prescribed by
the Commission under section 19(a) of
that Act (15 U.S.C. 17a(s)) or section
13(b) of the Securities Exchange Act of
1934 (15 U.S.C. 78a(m)); and
(ii) relevant to audit reports for
particular issuers, brokers, or
dealers, or dealt with in the quality
control system of a particular
registered public accounting firm; and
(B) auditing standards, standards for
attestation engagements, quality control
policies and procedures, ethical and competency
standards, and independence standards
(including rules implementing title II) that
the Board or the Commission determines--
(i) relate to the preparation or
issuance of audit reports for issuers,
brokers, or dealers; and
(ii) are established or adopted by
the Board under section 103(a), or are
promulgated as rules of the Commission.
[(6)] (9) Self-regulatory organization.--The term
``self-regulatory organization'' has the same meaning
as in section 3(a) of the Securities Exchange Act of
1934 (15 U.S.C. 78c(a)).
* * * * * * *
MINORITY VIEWS
H.R. 6021 would exempt some of the worst-performing
auditors in our capital markets from federal scrutiny.
Specifically, the bill would create a permanent statutory
exemption for audits of certain privately held brokers and
dealers that do not ordinarily receive and or hold client
assets (i.e., ``non-custody'' firms) from Public Company
Accounting Oversight Board (PCAOB) oversight.
In recognition of the role auditing failures played in
enabling Bernie Madoff's $65 billion Ponzi scheme, the Dodd-
Frank Act gave the PCAOB oversight authority over the audits of
all brokers and dealers registered with the SEC. Congress, in
doing so, charged the PCAOB with the task of setting standards
for auditors of broker-dealers and ensuring their compliance
through annual inspections. Far from a ``one-size fits all
requirement,'' the Dodd-Frank Act gave the PCAOB express
authority to tailor its inspection program to, ``allow for
differentiation among classes of brokers and dealers, as
appropriate.''\1\ Additionally, the Dodd-Frank Act clearly
aligned PCAOB oversight with the inspection program so that any
auditor the PCAOB decides to exempt from inspection would not
be required to register with the PCAOB or adhere to PCAOB
standards.\2\
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\1\See Pub. L. No. 111-203 982(e)(1).
\2\See 15 U.S.C. Sec. 7214(a)(2)(D) (``. . . a public accounting
firm shall not be required to register with the Board if the public
accounting firm is exempt from the inspection program which may be
established by the Board. . . .'').
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Although the PCAOB currently subjects broker-dealers of all
classes to inspection, the program is in a temporary phase
designed to inform the PCAOB's determination of how to
ultimately tailor its permanent inspection program. Despite
these ongoing fact-finding efforts, H.R. 6021 would statutorily
exempt audits of certain brokers and dealers from PCAOB
oversight. The bill is unnecessary as the PCAOB possesses
express authority to tailor its inspection program through a
rulemaking process that would (1) take into account the PCAOB's
unique insight into the performance of broker-dealer auditors
and (2) be subject to public notice and comment and approval by
the SEC.
In addition to being unnecessary, H.R. 6021 is far too
broad in scope. The bill's exemption applies to broker-dealers
with up to 150 representatives--a number derived from the
definition of ``small firm'' included in the by-laws of the
Financial Industry Regulatory Authority (FINRA), the self-
regulatory organization for the broker-dealer industry.
However, the number of representatives that a brokerage firm
employs bears no meaningful relationship to the complexity of
the firm's finances for auditing purposes. Even limited to non-
custody firms, this threshold accounts for approximately 80% of
registered broker-dealers.
Moreover, according to the results of the PCAOB's interim
inspection program, reduced auditing oversight appears to be
unwarranted for the very class of broker-dealers that H.R. 6021
would exempt. The PCAOB has consistently found that auditors of
non-custody broker-dealers generally have a higher rate of
deficiencies than other firms. These deficiencies include
material auditing failures such as inadequate revenue testing
and overlooking red flags that could indicate fraud. In fact,
in its fiscal year 2017 inspections, the PCAOB found that 71%
of audits of non-custody firms had deficiencies related to
``assessing and responding to risks of material misstatement
due to fraud.''\3\ By comparison, the same deficiency was
observed in 50% of audits for custodial brokers and dealers.
Overall, the PCAOB found deficiencies at 85% of the 54
inspected auditing firms that only audited non-custody brokers
and dealers. These results counsel against eliminating
oversight over the performance of these auditors.
---------------------------------------------------------------------------
\3\See Annual Report on the Interim Inspection Program Related to
Audits of Brokers and Dealers, PCAOB Release No. 2018-003 (Aug. 20,
2018), available at https://pcaobus.org/Inspections/Documents/Broker-
Dealer-Auditor-Inspection-Annual-Report-2018.pdf.
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The exemption contemplated by H.R. 6021 is inappropriate
considering the prevalence of auditing deficiencies among
auditors of non-custody brokers and dealers. Additionally, the
bill ignores the fact that auditors represent a primary,
independent source of verifying how a brokerage firm treats
client assets. Importantly, FINRA employs a risk-based approach
to its oversight, pursuant to which it relies, in part, on a
broker-dealer's audited filings to determine the degree of
supervision it will apply to a particular firm.
By eliminating auditing oversight for self-proclaimed non-
custody broker-dealers, H.R. 6021 would erode an important
accountability mechanism and potentially put investors at risk.
For these reasons, we oppose H.R. 6021.
Maxine Waters.
Carolyn B. Maloney.
Nydia M. Velazquez.
Wm. Lacy Clay.
Michael E. Capuano.
[all]