New Proposal Calls for Stronger Broker-Dealer Audits

The Securities and Exchange Commission (SEC) is contemplating new regulations that would create tougher audits for broker-dealers that do not use outside firms to handle client funds. Essentially, public accounting firms would have greater authority to conduct audits to ensure that brokerage firms are in compliance with existing rules. Borne out of the 2009 rules intended to prevent future financial scandals, money managers would have to comply with several rules involving the protection of client funds.

Essentially, broker-dealers would be required to maintain at least one dollar of highly liquid assets for each dollar of liabilities. They also would have to segregate customer securities and cash from the firm’s proprietary business activities. Auditor examinations also would focus on making that accurate quarterly statements are sent to clients.

This would be slightly different from the previous rule, which called for surprise examinations of hedge funds, mutual funds, buyout shops and other investment firms that have custody of their clients’ assets by an independent public accountant.

Federal authorities believe that the now-infamous Bernie Madoff’s unique custody arrangement allowed him to maintain access to his investors’ funds in order to manipulate them and to send out false reports to investors. Authorities also believe that under the new SEC rules, Madoff’s financial custodian would have been required to have its structure for protecting customer’s assets examined by a registered public accounting firm, thus limiting his ability to manipulate the data.

In supporting the new proposal, SEC Chairwoman Mary Schapiro explained, “The goal would be to enhance the SEC’s examination of the broker-dealer by building on the work performed by the accounting firm, particularly in the area of verifying the custody of customer assets.”

The proposed regulations would affect nearly 300 broker-dealers that do not hire independent custodians to monitor client funds. Independent audits are a common practice in the post-Madoff era. A majority of the nearly 5,000 U.S. broker-dealers registered with the SEC employ independent outside custodians to hold client assets. These money-managers would not be subject to these new conditions.

If you have questions about the how the new regulations may apply to you, an experienced securities attorney can advise you of your rights.