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The Small Business Audit Correction Act - Summary (6/27/18)

The Small Business Audit Correction Act (HR 6021) - Summary

HR 6021 would right-size audit requirements for eligible small broker-dealer firms.

•    HR 6021 amends Sarbanes-Oxley (SOX) to exempt small, privately-held, non-custodial firms “in good standing” from the mandatory Public Company Audit Oversight Board (PCAOB) audit and returns these firms to the prior SEC 17a-5 requirement whereby these brokers submit audited financials to the SEC, FINRA and States according to the AICPA’s Generally Accepted Auditing Standards. 

•    Small “Introducing Brokers,” i.e. those that don’t take custody of client assets, are now paying significantly-increased audit costs due to a Dodd-Frank expansion of SOX. The current audit requirements are inappropriate and unnecessary for certain non-custodial firms. 

    The PCAOB audit requirement is a well-intentioned response to the Madoff scandal, but it has ensnared brokers who are incapable of Madoff-style scams since all customer assets are held at custodial firms like BNY Mellon, Wells Fargo and Pershing.

    Both the SEC & PCAOB have acknowledged that they have no data to demonstrate positive outcomes as a result of this requirement. Yet both entities acknowledge the increase burden on small firms, both financial and the human resource drain.

    Audit bills have increased exponentially from roughly, for example, $6000 in 2012 to $30,000 in 2017 with no increase in customer protection.

    An organized group of 3000+ small non-custodial broker-dealers has been reaching out to House & Senate members. This is their #1 priority.

Endorsements and News Articles
Over 800 small firms (from 49 out of 50 states) have signed a letter in support of HR 6021. Note: that this is a sample of the 3000 or so firms in this category.
•    John Berlau at CEI wrote in favor of the bill. 
•    Investment News article.

Groups in favor of HR 6021
*US Chamber of Commerce
*Bond Dealers of America (BDA)    
*Financial Services Institute (FSI)    
*Investment Program Association (IPA)    
*National Investment Banking Association (NIBA)
*Securities Industry and Financial Markets Association (SIFMA)

Neutral Consumer/Regulatory Groups
Better Markets    
American Institute of Certified Public Accountants (AICPA)
North American Securities Administrators Association (NASAA)
Small businesses in the investment and accounting industries are asking for your support in passing the Small Business Audit Correction Act of 2018. This Act would exempt privately-held, small non-custodial brokers and dealers in good standing from the requirement to hire a Public Company Accounting Oversight Board (PCAOB)-registered audit firm to meet their annual SEA Rule 17a-5 reporting obligation and would instead reinstate the prior regulatory audit requirements.

Investment industry Brokers and Dealers are required by law and regulation to have an annual audit that produces audited financial statements. Around the turn of the century there were a slew of corporate scandals that resulted in Congress passing the Sarbanes-Oxley Act of 2002 with the intent to protect shareholders and investors from fraudulent corporate accounting and audit practices. Fast forward to the devastation of Madoff and the 2007-08 financial crisis and we saw Congress enact the Dodd-Frank Act in an effort to protect the investing public from, in part, corporate malfeasance. Included in both Acts are legislative language that changed the rules for Broker/Dealer annual audits. 

Prior to Sarbanes-Oxley, as amended by Dodd-Frank, Brokers and Dealers were required to hire a certified public accounting firm which followed Generally Accepted Auditing Standards (GAAS) when conducting Broker/Dealer annual audits. Following the enactment of the Acts, Broker/Dealers, irrespective of size, were required to hire a PCAOB-registered auditor who followed the PCAOB-defined set of audit standards, which are markedly different and significantly more complex than GAAS. The reason they are more complex is because they were designed and intended for use in the performance of financial audits of public companies with public shareholders, not privately-owned small businesses like ours. 

The PCAOB audit requirement is appropriate and the right fit for public companies and Broker/Dealers which carry customer funds or securities, like JP Morgan or Morgan Stanley, because the investing public and markets are potentially at greater risk from these companies. The PCAOB audit requirement has ensnared small companies that are incapable of Madoff-style scams since all customer assets are held at custodial firms like Pershing.  

Conversely, the PCAOB audit requirement does not make sense and is the wrong fit for privately-held, non-custodial, small Broker/Dealers. Our companies are not publicly traded companies and therefore do not have any public shareholders (“investors”) and we do not hold or carry customer funds or securities in our own accounts, choosing instead to hand those risks off to a clearing firm. The small firm Broker/Dealer community represents over 90% of the firms in the brokerage industry and almost three-quarters of our companies employ 20 or fewer people. The one-size-fits-all regulation and oversight approach that holds a 3-person brokerage firm to the same standards as JP Morgan, Merrill Lynch, or Morgan Stanley is unreasonable, unfair, and not working

In 2012, there were 783 PCAOB-registered audit firms. By 2016, there were only 478 PCAOB-registered audit firms. That is nearly a 40% reduction in the number of audit firms eligible to audit all public companies as well as the approximately 3700 Broker/Dealers around the country. The scarcity of supply, combined with public companies and the investment industry’s demand, has resulted in unsustainable cost increases for small businesses. 

The one-size-fits-all PCAOB audit requirement has inflicted substantial harm to small broker dealer businesses with limited human and financial resources. These PCAOB audits cost multiples of what our prior audits cost and take 3-5x the number of man-hours to complete, and we simply cannot continue to sustain these burdens; these complex and expensive audits are contributing meaningfully to the current trend of small firm demise. Small businesses have limited resources, both human and financial, and the audit pricing and workload associated with the PCAOB requirement are quite literally crushing small Broker/Dealers and driving us out of business at an alarming rate. 

Paige Pierce