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FINRA, Grant Thornton Eye Madoff, Dodd-Frank Effect on Broker-Dealers

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At an informal post-Madoff breakfast in New York on Wednesday, audit and advisory firm Grant Thornton invited a FINRA regulator to meet with broker-dealers and hash out all the rule changes associated with Dodd-Frank reform.

The mood was friendly enough among the finance professionals in the Hyatt conference room next to Grand Central Station. But the issues that came up for a panel discussion were serious—and reflective of broker-dealers’ uncertainty surrounding audits, third-party custody, newly required compliance examinations and whether threatened U.S. budget cuts will hamper regulators’ lofty goals for scrutinizing BDs’ operations more closely.

“When any regulator sees a rule that another regulator already has, they say, ‘I have to have that rule, but I want to make it stricter,’” said Steven Lofchie, a partner at law firm Cadwalader, Wickersham & Taft, who sat on the panel. “I pride myself on my dislike of Dodd-Frank,” Lofchie said by way of introducing himself.

Lofchie, who noted that “my remarks may make me look anti-regulatory, but I am in fact a regulatory lawyer,” used the Commodity Futures Trading Commission’s position limits rule as his example. Dodd-Frank and the Securities and Exchange Commission have only complicated a requirement that the CFTC had already put into place, he asserted.

Seated to Lofchie’s right was Grace Vogel, executive vice president of member firm regulation with the Financial Industry Regulatory Authority, who had come to the breakfast to talk about the potential impact of proposed FINRA rules on broker-dealers.

Vogel and Lofchie agreed that third-party custody was one of the most important issues—if not the most important issue—that broker-dealers faced since Bernie Madoff was caught cooking his books.

They also agreed that technology has created ample opportunities for people looking to defraud investors.

"Don't be surprised if a FINRA official asks to sit down with someone in your broker-dealer operations and asks them to log into their DTCC terminal to verify specific positions," Vogel said. "At FINRA, we have had examiners doctor documents with Photoshop to show large balances on Chase bank statements to demonstrate how easy it is to produce fraudulent statements."

Also on the docket at the breakfast were FINRA’s regulatory notice 10-44, FINRA’s proposed 10-25 rule governing examinations of operations professionals and an update on matters up for discussion with the American Institute of Certified Public Accountants (AICPA).

The SEC is expected to make amendments to Rule 17a-5 later this year, according to

Grant Thornton partner Mark Ramler, who is a member of the AICPA’s stockbrokerage and investment banking expert panel.

Expected amendments to the rule include:

  • A new form to report custody of customer funds and securities
  • Access to meet with auditors and reviewing audit workpapers
  • Clarification of audit and attestation standards to be used for internal control letters

In the post-Madoff world, “we have spent a lot of time with the SEC discussing the role of the external auditor,” Ramler said.

The 10-25 rule’s examination of professionals raised questions for broker-dealers at the breakfast because, as Vogel noted, some of them will have to pass the regulatory exam. Many of those taking the exam have been in the business for 30 or more years, and there is some concern that these people won’t be able to pass the exam, she said.

Examination priorities include valuation, leverage, intercompany transactions, liquidity, asset verification, controls around direct market access, outsourcing, master subaccounts and foreign control locations.

While U.S. regulators’ ambitions under Dodd-Frank reforms are great, their reach may exceed their grasp, Lofchie said toward the panel’s conclusion.

“There are not enough legal, compliance and technical people to get all of this work done,” he said.

Grant Thornton Principal Steven Goldberg concurred, adding that in the current political climate of budget-cutting and regulatory opposition, “we’re in an environment of deep uncertainty.”

Read “SEC's Schapiro: Agency Will Turn to Fiduciary, Harmonization, 12b-1 After July 21” at