Watchdogs Put Closer Eye on Broker-Dealer Accounting

Regulators like the FINRA are taking a closer look at broker-dealers just as accounting missteps are on the rise.
Kathy HoffelderMay 10, 2012

Regulators like the Financial Industry Regulation Authority say accounting mistakes by broker-dealers are becoming more prevalent in everything from accruals to improper netting.

“We are seeing a lack of accruals for contingencies,” said Kris Dailey, vice president in the Risk Oversight & Operational Regulation Division at the FINRA at a New York State Society of CPAs’ Foundation for Accounting Education conference yesterday. “It’s one of the areas that we as auditors would like to see a focus on.”

Dailey noted that this lack of preparation often leads to a lack of efficiencies at broker-dealer firms at a time when regulatory scrutiny is more intense. A lack of accruals for contingencies, such as a loss that might arise from arbitration, is an area the FINRA flags during all of its broker-dealer examinations, she said.

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Other problems arise with respect to guarantees among firms. Liabilities of parent companies or affiliates of broker-dealers are many times not properly accounted for, she noted. Several of the problems exist with broker-dealer management-service agreements, in particular.

Expenses too tend not to match the services provided, which is a common theme among some of the accounting missteps lately, though there are a number of exceptions in the fee area, added Dailey.

Improper netting (the practice of settling obligations at the net value of a contract rather than its gross value) is another high priority area for the FINRA when it comes to broker-dealer examinations. “We see a lot of improper netting on the balance sheet,” said Dailey. Receivables from different parties that should not be netted, she explained, are routinely netted by mistake.

In its January examinations priority list, the FINRA highlighted the importance of netting correctly. While it is not uncommon for firms to grow their balance sheets amid the current low-interest-rate environment, the FINRA noted the netting of assets and liabilities for financial-statement purposes also tends to increase at this time. “We will continue to monitor firms that employ a high degree of leverage, both on-balance sheet and off-balance sheet during the upcoming year,” it said.

Outsourcing third-party broker-dealer services is also a key area of concern for regulators. The FINRA currently has a proposed rule under review by the Securities and Exchange Commission that cites the need for broker-dealers to still maintain the right supervisory controls when outsourcing functions. It is important for firms to know that broker-dealers are responsible for a function even though it is outsourced, said Dailey.

Other regulators such as the Commodity Futures Trading Commission are also cracking down on broker-dealer accounting policies. The CFTC, for one, is taking a closer look at having a more formal analysis of the P&L review process for broker-dealers, said Kevin Piccoli, deputy director of examinations in the Division of Swap Dealer and Intermediary Oversight at the CFTC, at the conference.

The CFTC is looking at not only whether it is appropriate to have a CFO or CEO at a broker-dealer sign off on liquidity withdrawals but also whether to have them confirm whether the broker-dealer is still compliant with segregation rules requiring separation of customer and firm accounts even after a firm has such a withdrawal, he said.

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