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Letter From SEC Director of Trading and Markets and the SEC Chief Accountant to Stephen Zammitti, Chair of the AICPA Stockbrokerage and Investment Banking Expert Panel Concerning Requirements for Broker-Dealer Annual Audits Pursuant to Rule 17A-5 Under the Securities Exchange Act of 1934 — November 18, 2010

Letter from SEC Director of Trading and Markets and the SEC Chief Accountant to Stephen Zammitti, Chair of the AICPA Stockbrokerage and Investment Banking Expert Panel Concerning Requirements for Broker-Dealer Annual Audits Pursuant to Rule 17A-5 Under the Securities Exchange Act of 1934

November 18,2010
AICPA Stockbrokerage and Investment Banking Expert Panel
Attention: Stephen Zammitti, Chair
1211 Avenue of the Americas
New York, New York 10036-8775
Re: Requirements for broker-dealer annual audits pursuant to Rule 17a-5 under the Securities Exchange Act of 1934
Dear Mr. Zammitti:
We have determined that it may be useful to remind auditors of the importance of complying with existing requirements of Rule 17a-51 that apply when conducting the "review of the accounting system, the internal accounting control and procedures for safeguarding securities" in connection with the annual audits of broker-dealers.
Rule 17a-5 under the Securities Exchange Act of 1934 ("Exchange Act") requires brokerdealers, among other things, to file annual financial reports, supporting schedules and supplemental reports with the Commission (as applicable).2 The supporting schedules filed with the annual financial statements must be comprised of a computation of required and actual net capital under Rule l5c3-1, and, if applicable, a computation of the customer reserve requirement under Rule 15c3-3 and information relating to the possession or control requirements under Rule 15c3-3.3
Pursuant to Rule 17a-5 and Exchange Act Section 17(e), the broker-dealer must file an accountant's report from a registered public accounting firm covering the annual financial statements and supporting schedules. The audit that supports the accountant's report must be conducted in accordance with generally accepted auditing standards. Auditors currently apply the professional standards of the AICPA.4 In addition, and as reflected in the excerpt from Rule 17a-5 included below, the registered public accounting firm also must perform a review of the accounting system, the internal accounting control and procedures for safeguarding securities.
The following is an excerpt from the requirements for the annual audit contained in Rule 17a-5:
The audit shall be made in accordance with generally accepted auditing standards and shall include a review of the accounting system, the internal accounting control and procedures for safeguarding securities including appropriate tests thereof for the period since the prior examination date. The audit shall include all procedures necessary under the circumstances to enable the independent public accountant to express an opinion on the statement of financial condition, results of operations, cash flow, and the Computation ofNet Capital under § 240.15c3-1, the Computation for Determination of Reserve Requirements for Brokers or Dealers under Exhibit A of § 240.15c3-3, and Information Relating to the Possession or Control requirements under § 240.15c3-3. The scope of the audit and review of the accounting system, the internal control and procedures for safeguarding securities shall be sufficient to provide reasonable assurance that any material inadequacies existing at the date of the examination in (a) the accounting system; (b) the internal accounting controls; (c) procedures for safeguarding securities; and (d) the practices and procedures whose review is specified [in Rule 17a-5] would be disclosed.5
The requirement above clearly states that the "scope ofthe audit and review...shall be sufficient to provide reasonable assurance that any material inadequacies existing at the date of the examination...would be disclosed."6 Material inadequacy for these purposes is defined in the requirements ofRule 17a-5.7
Consistent with this rule, the Broker-Dealer Audit Guide states that "in planning and performing the audit of financial statements, the auditor should obtain reasonable assurance that any material inadequacies existing at the audit report date...would be disclosed."8 The Broker Dealer Audit Guide further states that "the audit should include a review of the broker-dealer's practices, procedures and controls to ensure compliance with the securities possession or control and the cash reserve elements of the Customer Protection Rule and should include those tests that the auditor considers necessary to provide reasonable assurance that any material inadequacies (and significant deficiencies or material weaknesses) existing at the date ofthe examination would be disclosed."1 In order to obtain reasonable assurance to support the reporting of material inadequacies to the Commission, the auditor should follow the requirements contained in existing professional standards, including the AICPA's Statements on Standards for Attestation Engagement.
Both the annual financial statement audit and the compliance examination procedures performed by the auditor are critical compliance elements relative to the Commission's regulatory oversight of broker-dealers. Auditors currently planning or performing audits of broker-dealers should ensure that they do so in a manner that is in conformity with the requirements ofthe applicable rules and professional standards.
If you have any questions, please contact John Ramsay, Deputy Director, Division of Trading and Markets, at (202) 551-5500 or Brian Croteau, Deputy Chief Accountant, Office of the Chief Accountant, at (202) 551-5300.
Sincerely,
Robert W. Cook
Director
Division of Trading and Markets
James L. Kroeker
Chief Accountant
Office ofthe Chief Accountant
cc: Charles Landes, AICPA Vice President, Professional Standards and Services
Cynthia Fornelli, Executive Director, Center for Audit Quality
Martin Baumann, PCAOB Chief Auditor and Director of Standard Setting
George Diaccint, Director, PCAOB Division of Registration and Inspections

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