Small B-Ds decry Hill audit proposal

Smaller broker-dealers are worried that a sweeping congressional proposal aimed at preventing fraud through comprehensive audits of brokerage firms could put them out of business.

Independent-brokerage firms, which don’t handle client funds because of their arrangements with clearing firms, said they would be bearing an unfair burden because the provision would require all broker-dealers to be audited by accounting firms regulated by the Public Company Accounting Oversight Board.

The measure is part of financial services reform legislation that is being considered by the Senate Banking Committee and which is expected to be taken up by the House in the next few weeks.

The Financial Services Institute Inc., the National Association of Independent Broker/Dealers and the American Institute of Certified Public Accountants are all pushing Congress to alter the provision.

“Introducing broker-dealer firms do not have custody of client funds and, as a result, are a far lower-risk than clearing and other firms that maintain custody,” said David Bellaire, general counsel and director of government affairs for the FSI, which represents independent broker-dealers.

Most of FSI’s members are introducing firms, and the provision would increase their cost of doing business, creating “an unnecessary expense for those firms that provides little or no investor protection,” Mr. Bellaire said.

“These costs will be passed on to investors,” he said. “It’s really a misallocation of resources that could be dedicated to areas that have greater potential for risk.”

Both the proposed Investor Protection Act, which will be brought before the full House for a vote next month, as well as draft reform legislation being considered by the Senate Banking Committee, include the provision.

Under current law, auditors of private brokerage firms are required to register with the PCAOB. However, the PCAOB only has the authority to discipline auditors of public firms through inspections and enforcement actions.

The aim of the proposed legislation is to prevent accounting firms from rubber-stamping audits for brokerage firms.

New York accountant David Friehling pleaded guilty to fraud and other charges this month for providing Bernard L. Madoff Investment Securities LLC with fraudulent audits, substantially assisting in Mr. Madoff’s $65 billion Ponzi scheme.

Rep. Paul Kanjorski, D-Pa., chairman of the House Financial Services Committee’s capital markets subcommittee, introduced legislation in February that would require PCAOB audits of all private brokerage firms, including introducing brokers.

The provision is now part of the House regulatory reform bill.

“Some introducing broker-dealers do handle customer cash,” Mr. Kanjorski wrote in an e-mail on the issue.

“For those not permitted to handle cash, only audits can confirm that those broker-dealers are in compliance,” he said. “Regulators have also found instances of fraud involving introducing broker-dealers, despite industry claims to the contrary.”

An amendment that would have exempted auditors of introducing broker-dealers from PCAOB oversight was defeated.

The intent of the legislation isn’t to place an undue burden on small companies but to provide “a system of rigorous oversight and enforcement so that customer assets are safe and investors have confidence in the markets,” Mr. Kanjorski wrote.

Under the legislation, the PCAOB would have authority to differentiate among types of broker-dealers, he added.

Indeed, PCAOB acting chairman Daniel Goelzer said that the PCAOB “would want to focus most of our audit oversight efforts on the firms that are either clearing or have custody of assets.”

He added, however, that the PCAOB, which hasn’t taken a stand on the legislation, would “probably devote some effort to looking at introducing firms,” since many introducing firms have been forced into liquidation.

The Securities Investor Protection Corp. paid out more than $137 million to liquidate introducing broker-dealers between 1996 and 2008, according to SIPC spokeswoman Ailis Wolf.

The cost of changing audit requirements could put many small introducing brokers out of business, said Stephen Distante, chief executive of Vanderbilt Securities LLC, which manages about $1 billion in client assets.

He is chairman of the NAIBD, which represents about 200 small brokerage firms. There are a total of about 4,500 small brokerage firms.

According to data received by the NAIBD, the provision would raise auditing fees for introducing brokers to between $50,000 and $100,000 per year, from current levels of $5,000 to $10,000, Mr. Distante said.

The NAIBD wants Congress to give the PCAOB the discretion to devise varying standards for different types of brokerage firms, according to spokeswoman Kaitlin Friedmann.

Even accountants, who stand to gain from the provision by reaping higher fees for the audits, oppose applying it to introducing brokers.

“We support an expansion of PCAOB authority, but only over those auditors who are doing work for broker-dealers who control client funds,” said Mat Young, director of congressional and political affairs at the American Institute of Certified Public Accountants, which is lobbying against the provision.

The requirement could drastically cut the number of auditors available to inspect introducing brokers, Mr. Young indicated. Currently, about 700 firms audit introducing broker-dealers, while fewer than 500 firms audit clearing brokerage firms, according to the AICPA’s estimates.

There is little overlap between the two groups of firms, Mr. Young said.

E-mail Sara Hansard at [email protected].