1 The Commission has recently adopted rule 17a-13 which will become effective on January 1, 1972. This rule, will require all broker-dealers who are subject to its provisions to at least once in each calendar quarter: (1) physically examine and count all securities held; (2) verify all securities in transfer, transit, pledged, loaned borrowed, deposited, failed to receive, or failed to deliver or otherwise subject to the broker-dealer's control or direction but not in its physical possession; 1 (3) compare the result of the count verification with the broker-dealer's records; and (4) record on the books and records of the member, broker or dealer all unresolved differences, no later than 7 business days after the date of each security examination, count, and verification. Rule 17a-13 should give us some experience with a regular box count and we then may better be able to make a determination as to the "surprise audit" and either fiscal or calendar year reporting of brokerdealers. The staff is currently considering a rule (also discussed in question 6 below) calling for greater disclosure to customers of the financial condition of brokerdealer firms. The rule will also require that the same information be filed with the Commission. This additional information, which would be similar in many respects to that obtained in form 10-K submitted by public broker-dealers, would be filed in conjunction with form X-17A-5. 6. The Division of Trading and Markets and the Office of the Chief Accountant are, as previously indicated, presently working on a proposed amendment to rule 17a-5 relating to reports provided to customers concerning the financial condition of a firm. II. USE OF CUSTOMERS' SECURITIES 7. As you know, the Commission has just published proposed rules providing for customer protection through the insulation of customer related assets and activities from a broker-dealer firms' assets and activities as well as by measures for reserves and for maintaining the integrity of securities belonging to customers. Our proposal is intended to protect all customer's funds and securities without causing operational strain. If you desire any additional information on these matters, please let me know. Sincerely yours, IRVING M. POLLACK, Director. I want to take this opportunity to express to each member of the panel the appreciation of this committee for your appearance and for your cooperation. It is most helpful to us and I hope that it will be of some help to the general public. With that, the committee will stand in adjournment. (Whereupon, at 12:23 p.m., the subcommittee adjourned, to reconvene at 10 a.m., Monday, September 27, 1971.) 1 Where such securities have been in said status for longer than 30 days. STUDY OF THE SECURITIES INDUSTRY MONDAY, SEPTEMBER 27, 1971 HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON COMMERCE AND FINANCE, COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE, Washington, D.C. The subcommittee met at 10 a.m., pursuant to recess, in room 2123, Rayburn House Office Building, Hon. John E. Moss (chairman) presiding. Mr. Moss. The subcommittee will be in order. This morning the Subcommittee on Commerce and Finance of the House Committee on Interstate and Foreign Commerce opens the third in its series of hearings in its study of the securities markets. Before we proceed any further, I would like to say that I regret that conflicts arising from other House business have made necessary the rescheduling of this hearing today. I hope that the panelists have not been unduly inconvenienced as a result. In our last hearing, we focused on problems of broker-dealer financial stability and safety of customers' funds and securities. Today we wish to explore accounting practices, including the need for uniformity and disclosure to customers of broker-dealers' financial condition and, in addition, the adequacy of audit procedures for broker-dealers. Once again we have determined that this hearing will take the form of a panel discussion rather than the usual formal presentation of statements. In this way, the subcommittee hopes it will be possible to achieve an interchange of views both between this subcommittee and the panelists and between the panelists themselves. At the outset, each panelist has been asked to present a brief summary of his views. The written statements will, of course, be made a part of the record, and the Chair at this point requests unanimous consent to include such statements in the record as they are presented. Is there objection? Hearing none, the record will be held open to receive them. I appreciate the difficulties inherent in the next request, but I ask that you keep your summaries as brief as possible. I would hope that 10 minutes would suffice. If there are points left uncovered, you may pick them up at a later stage in our discussion. To make the record clear and simplify the task of the reporter, please identify yourself before presenting your remarks and also later in the discussion if this seems necessary. For the record, I might briefly summarize the three areas I touched on earlier in my remarks as outlined in the questions addressed to the panelists in the letter of invitation. (995) 67-228 0-71-pt. 2- -17 First, are uniform accounting procedures and systems for brokerdealers feasible and desirable? How much of an effort would be involved in establishing them and what would be gained as a result? Could uniform reporting be accomplished without such uniform systems of accounts and what would be its application? Second, are presently followed standards of disclosure of brokerdealer finances to their customers adequate? If not, what additional information should be furnished? Third, are current procedures used in the auditing of broker-dealers adequate? An exposure draft on audit procedures was recently issued for comment by the American Institute of Certified Public Accountants. At about the same time, a report, critical of certain past practices, titled, "The Auditors of Wall Street," was released by the Honorable Louis J. Lefkowitz, attorney general of the State of New York. In the light of these documents, should "surprise" audits be abolished? Should there be periodic changes of accounting firms so as to achieve greater independence? To deal with these questions, we are pleased to welcome this morning the following panelists: Mr. S. Leland Dill of Peat, Marwick, Mitchell & Co., chairman of the committee on stockbrokerage accounting and auditing of the American Institute of Certified Public Accountants; Mr. Leonard M. Savoie, executive vice president of the American Institute of Certified Public Accountants; Mr. Frederic W. Grannis, chief examiner, New York Stock Exchange, Inc., department of member firms; Mr. Andrew Barr, chief accountant of the Securities and Exchange Commission; Mr. David Clurman, assistant attorney general, State of New York, Bureau of Securities and Public Financing; and Mr. Harry V. Keefe, Jr., president of Keefe, Bruyette & Woods, Inc. Gentlemen, we are very pleased to welcome you here and, at this time, the Chair will recognize Mr. Leland Dill. STATEMENT OF S. LELAND DILL, PEAT, MARWICK, MITCHELL & CO., CHAIRMAN, COMMITTEE ON STOCKBROKERAGE ACCOUNTING AND AUDITING, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS Mr. DILL. I am S. Leland Dill, chairman of the American Institute. of Certified Public Accountants Committee on Stockbrokerage Accounting and Auditing. I am also a partner in the public accounting firm of Peat, Marwick, Mitchell & Co. I appreciate the opportunity to be here today and to be able to comment on the questions posed by the subcommittee. The subject matter is of great interest to me and to the other members of my committee. For the most part, I believe my comments and views represent the current thinking of the AICPA committee. However, it was not practicable to obtain a consensus on all of the points contained in my statement. We have submitted a written statement in endeavoring to answer the questions posed by the subcommittee. I would like to comment briefly on some of the questions that were posed. On the question of the cost of installation of uniform accounting procedures, I believe it is fair to estimate that the cost of the installation could be substantial, particularly in those instances where computer programing is necessary. It would also require a substantial effort by an industry regulator, presumably the Securities and Exchange Commission, to develop and define specific descriptions for the numerous accounts that would be necessary for an industry with diverse business activities. The adoption of uniform accounting procedures would result in standardized reporting throughout the industry. To the extent that resulting data would provide meaningful cost accounting comparisons, it could serve to measure reasonableness of commission rates. The practical difficulty with this concept is that a large portion of the brokers' costs relate to execution and clearance functions which would have to be allocated to the varying sources of income on an arbitrarily determined basis. We believe uniform reporting to be a more practicable approach. Among the common objectives of the regulatory agencies is surveillance of brokers for compliance with net capital rules, sound operational procedures, and adherence to the securities laws, all of which are intended to safeguard the interest of the customer. Therefore, it seems logical to me that reports providing accounting data and other information related to these common objectives could be uniform in form and in content. Uniform reporting could be achieved without the installation of uniform accounting procedures by each individual brokerage company. It would require a high degree of cooperation among the regulators in establishment of guidelines, not only as to form and as to content but as to the definition of items included in the reports. On the question of customer disclosure of broker-dealer financial condition, the AICPA Committee on Stockbrokerage Accounting and Auditing has made specific recommendations as to disclosure of financial information on broker-dealers. These recommendations are contained in the audit guide, "Audits of Brokers and Dealers in Securities," exposure draft issued for comment in July 1971. The exposure draft attempts to pinpoint and to give examples of methods of reflecting and disclosing financial data applicable to the securities industry. Certain of these recommendations represent a departure from past general practices and reflect the current thinking of the accounting profession on what is needed to inform the customer as to the financial position of the broker-dealer at the audit date. A high percentage of broker-dealers are presently privately owned, and it has been only in the last year or so that the number of publicly held brokerage companies has increased. The audit requirements of the Securities and Exchange Commission and various stock exchanges call for only a balance sheet for those broker-dealers who are privately owned. The events of the past 2 years emphasize the importance of profitability or the lack thereof to the broker-dealer who was required to comply with net capital ratio. Trends of the diminishment of excess net capital because of continued unprofitable operations are an important part of the evaluation of the broker-dealer by the public investor, his customer. Disclosure of this information could be accomplished by |