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Banking Securities Update Grant Thornton Winter 2011

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  • 1. Banking & Securities UpdateWinter 2011
  • 2. In this issue 3 Banks 10 Broker-dealers Audit and accounting update Audit and accounting update 3 Update on the FASB’s Financial Instruments Project, 10 Derivatives reform legislation including credit impairment and fair value 10 SEC assessment of customer assets and the impact 3 U.S. Department of Housing and Urban Development on FOCUS reports (HUD): Financial statement requirements revised for 10 Amending Rule 17a-5 and report parent-subsidy structures 11 SEC and PCAOB to place renewed focus on broker- 4 Deferral of troubled debt restructuring disclosures dealers’ financial statements 5 Grant Thornton issues updated guidance on 12 FASB proposes amended guidance on accounting accounting for loan participations and securitizations for repos 5 Overview of the Small Business Lending Fund 13 Board proposes to converge offsetting of financial assets 5 OCC issues updated guidance on common and liabilities and derivatives accounting issues for banks 5 The American Institute of Certified Public Financial Industry Regulatory Authority (FINRA), SEC, Accountants (AICPA) issues Audit Risk Alert: Financial Public Company Accounting Oversight Board (PCAOB) Institutions Industry Developments — Including and corporate governance updates Depository and Lending Institutions and Brokers and 14 Retaining control over customer assets Dealers in Securities 14 Regulatory Notice 10-33, Supplemental FOCUS Information SEC and Public Company Accounting Oversight 14 Regulatory Notice 10-22, Obligation of Broker-Dealers Board (PCAOB) update to Conduct Reasonable Investigations in Regulation D 6 SEC staff describes common reporting issues for Offerings financial institutions 14 Amendment to FINRA Rule 4560, Short Interest Reporting 6 SEC issues Proposed Rule on short-term borrowings 15 PCAOB: Interim audit inspection program and funding and an Interpretive Release on liquidity disclosures rules proposed for broker-dealers 6 SEC letter addresses disclosure obligations for mortgage and foreclosure activities Tax update 7 SEC issues Final Rules to regulate asset-backed 16 Cost-basis reporting securities 16 State nexus issues 8 PCAOB Alert discusses litigation and other contingencies related to mortgage activities 17 Resources Tax update 9 Recent trends and opportunitiesAbout this publicationAudit committees, management and boards of directors alike of banks and securities firms must keep pace with emergingregulations, new rules stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), as wellas current and upcoming accounting pronouncements. Grant Thornton LLP’s Banking & Securities Update provides brief updateson the key audit, accounting, regulatory and tax issues you need to know to fulfill your responsibilities.
  • 3. BanksAudit and accounting updateUpdate on the FASB’s Financial • The FASB/IASB agreed on a credit U.S. Department of Housing andInstruments Project, including credit impairment model that would Urban Development (HUD): Financialimpairment and fair value recognize lifetime expected credit statement requirements revised forThe Financial Accounting Standards losses using a time-proportionate parent-subsidy structuresBoard (FASB) and International approach for a good book and full A rule titled Federal HousingAccounting Standards Board (IASB) recognition of lifetime expected Administration: Continuation ofcontinue to hold frequent meetings on losses for a bad book. Readers should FHA Reform — Strengthening Riskthe financial instruments project. These be aware that the boards issued an Management Through Responsibledeliberations are expected to continue exposure draft, which is available on FHA-Approved Lenders becamefor most of the second quarter of 2011. the FASB website, to solicit feedback effective in May 2010. Under this rule,As of Jan. 31, 2011, the following on Jan. 31, 2011. supervised mortgagees with fiscal yearstentative decisions have been reached by ending on or after Jan. 1, 2010, mustthe boards in its re-deliberations of the • The boards have not yet discussed submit audited financial statements withexposure draft: hedging; however, the IASB issued their 2011 renewal and must also submit an exposure draft in December 2010, annual audited financial statements to• The FASB decided to define when in which the FASB plans to issue a HUD within 90 days of their fiscal year- financial assets should be classified discussion paper to solicit feedback end. This is a shorter timeframe than and measured at amortized cost, on the IASB’s exposure draft. required by the bank and credit union rather than at fair value. The FASB regulatory agencies, which typically decided that such determination Further updates on the Financial require audited financial statements to be should consider the entity’s business Instruments Project, including summaries submitted within 120 days of fiscal year- activity and whether financial assets, of Board meetings, can be found in end. Annual audited financial statements such as loans, are managed for the Grant Thornton’s weekly On the now are required for all supervised collection of contractual cash flows. Horizon publication at mortgagees, including some institutions www.grantthornton.com/onthehorizon. that otherwise are not required to have an audit.3 Banking & Securities Update – Winter 2011
  • 4. HUD recently issued Mortgagee Deferral of troubled debt restructuring • For disclosures about activity thatLetter 2011-05, Revised Audited disclosures occurs during a reporting period, forFinancial Statement Reporting The FASB has issued Accounting the first interim or annual reportingRequirements for Supervised Lenders Standards Update (ASU) 2011-01, period beginning on or after Dec. 15,in Parent-Subsidiary Structures and Deferral of the Effective Date of 2010. For a public company with aNew Financial Reporting Requirements Disclosures about Troubled Debt calendar year-end, those disclosuresfor Multifamily Mortgagees. The letter Restructurings in Update No. 2010-20, are initially required for the interimpermits supervised lenders in parent- which temporarily defers the date when period ending March 31, 2011.subsidiary structures (subsidiaries) public-entity creditors are required toapproved by the Federal Housing provide the new disclosures for troubled For nonpublic entities, the effectiveAdministration (FHA) to submit the debt restructurings specified in ASU date for the troubled debt restructuringaudited consolidated financial statements 2010-20, Disclosures about the Credit disclosures in ASU 2010-20 continues toof the parent company, accompanied Quality of Financing Receivables and the be for the first annual reporting periodby internally prepared consolidating Allowance for Credit Losses. The deferred ending on or after Dec. 15, 2011 — thatschedules, if one of the following effective date will coincide with the is, the annual period ending Dec. 31,conditions is met: effective date for the clarified guidance 2011 for nonpublic entities that have a about what constitutes a troubled calendar year-end.• The subsidiary accounts for at least debt restructuring, which the Board 40 percent of the parent company’s is currently deliberating in a separate Potential impact assets. project. That clarified guidance, expected The new disclosures on credit quality• The subsidiary provides the FHA by March 31, 2011, is expected to apply and the allowance in ASU 2010-20 with an executed corporate guarantee for interim and annual periods ending are still required but requested new agreement, acceptable to the secretary after June 15, 2011. Grant Thornton disclosures about troubled debt of HUD, between it and the parent submitted a comment letter to the FASB restructurings have been deferred. All company in which the parent on this matter. financial institutions should consider company guarantees the ongoing net It is important to note, however, implementation issues associated with worth and liquidity compliance of that the deferral in ASU 2011-01 applies these disclosures. In addition, it is the subsidiary. only to the troubled debt restructuring important to note that non-calendar year disclosures for public-entity creditors financial institutions must adopt the new The letter also introduces in FASB Accounting Standards disclosures in ASU 2010-20 beginningreporting requirements for mortgagees CodificationTM (ASC) 310-10-50-31 with the first interim period ending afterparticipating in FHA’s multifamily through 50-34, Receivables. The deferral Dec. 15, 2010. For example, a financialprograms by requiring them to report in ASU 2011-01 does not affect the institution with a June 30 year-endloan fees earned in excess of five percent effective date of the other disclosure would need to apply the disclosuresof the insured loan amount on each requirements in ASU 2010-20. Public in ASU 2010-20 (as amended by ASUFHA-insured loan of more than entities must initially provide those other 2011-01) beginning with the quarter$2 million endorsed during the fiscal disclosures as follows: ended Dec. 31, 2010.year period covered in their auditedfinancial statements. Such fees should be • For disclosures required as of the endreported on a separate schedule included of a reporting period, for the firstwith the annual audited financial interim or annual reporting periodstatements submitted to HUD. ending on or after Dec. 15, 2010. The new disclosures on In addition, HUD released a For a public company with a calendar credit quality and thefrequently asked questions document year-end, those disclosures are initially allowance in ASUto address common questions related to required for the year endedMortgagee Letter 2011-05. Dec. 31, 2010. 2010-20 are still required The provisions of the Mortgagee but requested newLetter are effective immediately. disclosures about troubled debt restructurings have been deferred.4 Banking & Securities Update – Winter 2011
  • 5. Grant Thornton issues updated Overview of the Small Business OCC issues updated guidance onguidance on accounting Lending Fund common accounting issues for banksfor loan participations and Created by the Small Business Jobs Act, In November 2010, the office of thesecuritizations the Small Business Lending Fund (SBLF) Comptroller of the Currency (OCC)Grant Thornton recently issued is a $30 billion fund that encourages updated its Bank Accounting Advisoryexpanded implementation guidance lending to small businesses by providing Series, which expresses the views of theon FASB Statement 166, Accounting Tier 1 capital to qualified community OCC’s Office of the Chief Accountantfor Transfers of Financial Assets: An banks with assets of less than $10 billion. on accounting issues of interest to nationalAmendment of FASB Statement No. 140. The price a bank pays for banks. The views in the series are neitherEffective Jan. 1, 2010, for calendar year- SBLF funding will be reduced as official rules nor regulations of the OCC.end companies, Statement 166 changes the bank’s small business lending Rather, they represent either interpretationsthe accounting for securitizations, loan increases. The U.S. Department of by the Office of the Chief Accountantparticipations, and other transfers of the Treasury (Treasury) will purchase or interpretations of regulatory capitalfinancial assets. Tier 1-qualifying preferred stock or requirements by the OCC. equivalents in each bank to provide the capital. Small business lending is defined AICPA issues Audit Risk Alert: Financial as providing certain loans of up to $10 Institutions Industry Developments million to businesses with up to $50 — Including Depository and Lending million in annual revenues. Institutions and Brokers and Dealers in Banks can visit the Treasury website Securities for information about the Small Business The AICPA recently released its Audit Lending Fund. Information currently Risk Alert entitled Financial Institutions only relates to C corporation depository Industry Developments — Including institutions and holding companies. Depository and Lending Institutions and Brokers and Dealers in Securities. Next steps This alert provides an overview of recent Please note that Treasury is working on economic, industry, technical, regulatory, separate SBLF terms for S corporations, and professional developments that affect mutual institutions and community audits and other engagements related to development loan funds. Treasury will those industries. The alert is available publish separate SBLF terms for these through the AICPA website. institutions at a later date. As part of the period certification to the Treasury, the entity must provide its auditor’s annual certification stating that the processes and controls used to generate supplemental reports to the Treasury are satisfactory. It is still unclear what the form of this certification will be.5 Banking & Securities Update – Winter 2011
  • 6. BanksSEC, PCAOB and regulatory updateSEC staff describes common reporting The presentation also highlights SEC letter addresses disclosureissues for financial institutions other issues with a special focus on obligations for mortgage andThe SEC published on its website a banks: foreclosure activitiespresentation titled Areas of Frequent • Implications on risk factors The SEC’s Division of CorporationStaff Comment – Financial Institutions • Loan accounting and allowance for Finance (CorpFin) recently sent ato provide an overview of issues that loan losses letter to certain public companies as athe staff of the Division of Corporation • Investments and other than reminder of their potential disclosureFinance frequently encounters when temporary impairment obligations in SEC filings related toreviewing filings for banks. Although • Modifications versus troubled debt representations and warranties made tofocused on banks, the information in restructuring purchasers of mortgages and mortgage-the presentation could provide useful • Disclosures around liquidity backed securities, and reviews of loanobservations for all types of financial • Internal control over financial documentation and foreclosure practices,services companies and their auditors. reporting including, in some cases, a temporary Some of the significant areas halt of foreclosure proceedings. CorpFindiscussed in the presentation include: SEC issues proposed rule on short-term posted a sample letter on the SEC website• Asset quality and loan accounting borrowings and interpretive release on to inform entities that may be impacted• Loss contingencies liquidity disclosures by these issues but did not receive a letter.• Securities and goodwill impairment The proposed rule is not effective The letter notes that the issues and• Valuation allowance on deferred tax for Dec. 31, 2010, 10-K filers, but related disclosures addressed affect not assets consideration of expanded liquidity only financial institutions, but also issuers• Variable interest entities and disclosures, as noted in the interpretive engaged in activities related to residential accounting for transfers of financial release, is necessary for all current mortgages, such as mortgage servicing, assets filings. More information is available in mortgage insurance, and title insurance.• Liquidity and risk management this Oct. 5, 2010, Grant Thornton New The letter lists examples of representations• Mortgage- and foreclosure-related Developments Summary. Visit and warranties that issuers may have made matters www.grantthornton.com/nds. to purchasers of mortgages or mortgage-• Regulatory actions backed securities. It also reminds issuers• Acquisition of troubled financial of their obligation under Regulation S-K, institutions and FDIC-assisted Item 303, to disclose in Management’s transactions Discussion and Analysis any known trends or demands, commitments, events,6 Banking & Securities Update – Winter 2011
  • 7. or uncertainties that could reasonably The staff asks issuers to consider several SEC issues Final Rules to regulatebe expected to have a material impact points in drafting their disclosures, asset-backed securitieson operations, liquidity, and capital including, but not limited to, the The SEC recently issued two Final Rulesresources. In addition, the staff letter notes following: to implement various sections of thethat Regulation S-K, Item 103, requires Dodd-Frank Act relating to asset-baseddisclosure of legal proceedings, including • Risks and uncertainties associated securities (ABS) offerings.those known to be contemplated by with potentially higher repurchasegovernment authorities, while Part II, requests, as well as any changes to Disclosure of repurchases related toItem 1 of Form 10-Q requires discussion the methodology or processes used outstanding ABSof legal proceedings both when they first to estimate any repurchase reserve The Final Rule, Disclosure for Asset-become a reportable event and when • Litigation risks and uncertainties Backed Securities Required by Sectionmaterial developments occur. These associated with any known or alleged 943 of the Dodd-Frank Wall Streetdisclosures are in addition to those – Defects in the securitization Reform and Consumer Protection Act,required under FASB ASC 450-20, process, including potential prescribes disclosure requirementsContingencies: Loss Contingencies. defects in mortgage related to representations and warranties The letter advises issuers to provide documentation or in the in ABS offerings. The Final Ruleclear and transparent disclosures about assignment of the mortgages, and requires securitizers of ABS to disclose arepresentations and warranties made the potential effects of such defects security’s repurchase history.in connection with mortgage sales and – Breach of pooling and servicing The Final Rule requires disclosure of thesecuritization activities. In addition, criteria, including potential following information for ABS offerings:it notes that issuers should discuss defects in the foreclosure process,the implications associated with any and the potential effects of • For securitizers of ABS: Forforeclosure reviews, including potential such defects outstanding ABS subject to a covenantdelays in completing foreclosures. The • Potential impact to the issuer’s to repurchase or replace an underlyingdisclosures should address an issuer’s liquidity and any effects on asset asset for breach of a representation orrole as a loan originator, securitizer, valuation and impairment resulting warranty, tabular disclosure of fulfilledservicer, and investor, as applicable. from changes in the timing of sales and unfulfilled repurchase requests on of loans, other real estate owned, and Form ABS-15G, regardless of whether mortgage-backed securities the securities were issued in a transaction registered with the SEC, to permit Finally, the letter requests that filers investors to identify asset originators consider disclosing a roll-forward of any with clear underwriting deficiencies. reserve related to representations and In an initial filing by Feb. 14, 2012, warranties associated with loans they securitizers are required to disclose have sold. their repurchase history for the three years ended Dec. 31, 2011. Thereafter, securitizers are required to file updated information quarterly that includes the repurchase history for all outstanding ABS and includes the history of allFinally, the letter requests that filers consider disclosing fulfilled and unfulfilled repurchase requests. Municipal securitizers have ana roll-forward of any reserve related to representations additional three-year phase-in periodand warranties associated with loans they have sold. for these disclosure requirements. In addition, there are disclosures required to inform investors of an issuer’s repurchase history in prospectuses and ongoing reports, with the phase-in period beginning Feb. 14, 2012.7 Banking & Securities Update – Winter 2011
  • 8. • For nationally recognized statistical Any registered ABS initially offered • gathering sufficient and appropriate rating organizations (NRSROs): A after Dec. 31, 2011, must comply with evidence for litigation, claims, and description of both of the following the new rules and forms. assessments; in any report accompanying a credit The Final Rule is effective March 28, • auditing accounting estimates when rating of ABS: 2011. relevant factors differ from those – the representations, warranties, considered in the past; and enforcement mechanisms PCAOB Alert discusses litigation • evaluating financial statement available to investors; and and other contingencies related to presentation and disclosure to – how the representations, mortgage activities determine whether management has warranties, and enforcement The PCAOB recently issued Staff Audit omitted information required by mechanisms differ from those in Practice Alert 7, Auditor Considerations GAAP or whether other information issuances of similar ABS. of Litigation and Other Contingencies accompanying the financial Arising from Mortgage and Other Loan statements is materially inconsistent NRSROs are required to provide Activities, to inform auditors of public with the financial statements; and that information for reports issued companies about their responsibilities • communicating with the audit six months or more after the effective when auditing loss contingencies, committee about management’s date of the Final Rule. disclosures, and related items associated judgments and accounting estimates with mortgage and foreclosure activities. and on matters that significantly The Final Rule is effective 60 days The staff issued the Practice Alert as impact representational faithfulness,after its publication in the Federal a result of a report by the Congressional such as disclosures aboutRegister. Oversight Panel in November 2010, representations and warranties which indicated that financial institutions related to securitization activities.Review of underlying assets required in might have misrepresented the quality ofofferings of registered ABS loans sold for securitization and couldThe Final Rule, Issuer Review of Assets be required to repurchase the affected Practice Alert 7 also observes thatin Offerings of Asset-Backed Securities, mortgages. The report also alleged that the December 2008 Staff Audit Practicerequires an issuer of registered ABS financial institutions might not have Alert 3, Audit Considerations in theto perform a review of the underlying performed procedures legally required Current Economic Environment, whichassets that, at a minimum, provides to foreclose on homes. According to addresses matters related to the 2008reasonable assurance that the disclosure the reports, estimates of potential costs, economic environment that might affectin the prospectus is accurate in all including litigation, associated with audit risk, continues to apply.material respects. The issuer is required mortgage repurchases and foreclosureto disclose the nature, as well as the irregularities could represent afindings and conclusions, of that review substantial exposure to the financialin the prospectus. institutions involved. Please note: The statements contained in Staff Audit Under the Final Rule, an issuer Practice Alert 7 discusses the Practice Alerts are not Board rules and are not Boardmay engage a third party to perform professional guidance auditors judgments on the conduct of any firm, auditor, or other person.the review of the underlying assets. If a should consider when auditing lossthird party is used, disclosure must be contingencies and disclosures andclear concerning whether the findings notes in particular how that guidanceand conclusions are those of the issuer relates to mortgage- and foreclosure-or those of a third party. If the issuer related activities and exposures. Topicsattributes the findings and conclusions to addressed include the following:the third party, the third party must benamed in the registration statement andconsent to being named as an expert.8 Banking & Securities Update – Winter 2011
  • 9. BanksTax updateRecent trends and opportunities • We continue to see more statesBanks, their boards, audit committees assert economic nexus, whichand management should be aware of a creates a liability when couplednumber of tax trends and opportunities. with the market state sourcing of apportionment values.• Various issues are emerging in combined reporting for financial • Our professionals have had success institutions, particularly in with clients obtaining significant the treatment of broker-dealer refunds for the Texas margin tax, subsidiaries in California and certain mostly due to significant reductions other states. in apportionment factors.• Market state sourcing for • With regard to real estate mortgage apportionment purposes is an investment conduit (REMIC) emerging trend. investments, banks should consider taxation of excess inclusion income• Seventeen states have adopted rules and the impact on state net operating to source apportionment values loss (NOL) carryovers. associated with asset management fees from regulated investment • Our clients have had success in companies (RICs), hedge funds and obtaining credits and incentives. funds of funds based on shareholder locations.9 Banking & Securities Update – Winter 2011
  • 10. Broker-dealersAudit and accounting updateDerivatives reform legislation For accounting purposes, CDS are Under the proposed changes, assetsAs part of efforts to reform the classified as derivatives and not insurance belonging to customers would beU.S. financial system, the Obama contracts, and are subject to the Financial carved out and reported separately inadministration has proposed legislation Accounting Standards Board (FASB) an amendment to the Form X-17A-5,that would bring the over-the-counter ASC 815, Derivatives and Hedging, Financial and Operational Combined(OTC) derivatives market, including (formerly FASB Statement 133, Accounting Uniform Single Report (FOCUS report).credit-default swaps (CDS), under for Derivative Instruments and Hedging Should this type of reporting becomefederal regulation. The Dodd-Frank Activities). Under the rule, CDS are carried required, both auditors and broker-Act would require the clearing of OTC at fair value. dealers must be prepared for additionalderivatives and would also institute work validating prices and reconcilingcapital and margin requirements SEC assessment of customer assets the settlement-date stock record to thefor broker-dealers. The legislation and the impact on FOCUS reports trade-date customer position.will continue to evolve as the SEC Currently, the value of a customer’s fullyand Commodity Futures Trading paid assets is not included in a broker- Amending Rule 17a-5 and reportCommission (CFTC) promulgates dealer’s financial statements. These assets Accounting firms should follow ATadditional rules; broker-dealers need to are reflected by quantity only in the Section 601, Compliance Attestation,be aware of the legislation’s scope and stock record of the broker-dealer and which makes reference to Rule 17a-5,unanswered questions that will remain released only on a memorandum basis. Reports to Be Made by Certain Brokersuntil these rules are defined. and Dealers. However, while the 17a-5 Next steps and potential impact report does not meet AT 601 standards,Next steps and potential impact Broker-dealers should be alert to the the types of compliance testing regardingThe legislation needs to determine response of the Securities Industry and safeguarding securities and practices andwhether CDS will be considered Financial Markets Association (SIFMA) procedures should be consistent with ATderivatives or insurance contracts for to address regulators’ concerns. 601 standards and the audit guide. Theregulatory purposes — it is not clear if SEC expects to send out a proposal forstate insurance regulators could claim revisions and amendments to Rule 17a-5oversight of these products. (potentially to require a compliance examination report or an integrated audit report) in the first half of 2011.10 Banking & Securities Update – Winter 2011
  • 11. SEC and PCAOB to place renewed The staff advises auditors to ensurefocus on broker-dealers’ financial that they comply with applicable SEC The letter states thatstatements rules, as well as professional standards the financial statementThe Dodd-Frank Act amended the including AICPA attestation standards,Sarbanes-Oxley Act of 2002 (SOX), when planning and performing audits of audit and the auditor’sauthorizing the PCAOB to establish broker-dealers. compliance examinationauditing and related standards to be used by Rule 17a-5 demands a heightened procedures are criticalregistered public accounting firms in their level of performance compared withpreparation and issuance of audit reports the level of assurance provided in compliance elements ofthat will be included in broker-dealer filings the internal control report that has the SEC’s oversight ofwith the SEC pursuant to Rule 17a-5 under been previously used to meet this broker-dealers.the Exchange Act of 1934. reporting requirement. The sample On Sept. 24, 2010, the SEC released report on internal control, as publishedinterpretive guidance regarding these in the AICPA Audit and Accounting 2) The panel discussed views on howauditing and related standards. The Guide — Brokers and Dealers in accounting firms should execute workguidance states that references in SEC Securities, will be acceptable while and what guidance they can providerules and staff guidance in the federal the SEC considers changes to Rule to firms. The PCAOB said it thoughtsecurities laws in GAAS (Generally 17a-5 and the PCAOB considers audit the existing requirements under 17a-5Accepted Auditing Standards) or to standards for broker-dealers’ financial provide a very high level of assurance,specific standards under GAAS, as they statements. In the interim, broker- and that nothing has changed — therelate to non-issuer brokers or dealers, dealers and their auditors should plan board just wants all accounting firmsshould continue to be understood to on providing clear documentation, as to have a consistent understandingmean auditing standards generally well as conducting thorough reviews and of SEC rules and complianceaccepted in the U.S. plus any applicable testing of the accounting and internal requirements. Accounting firmsSEC rules. However, the SEC plans control procedures for compliance with should follow AT 601, which makesto revisit this interpretation in light of safeguarding securities and net capital reference to 17a-5. However, whileits rulemaking project to update these computations. the 17a-5 report does not meet ATrequirements under the Dodd-Frank Act. The AICPA Stockbrokerage and 601 standards, the types of compliance On Nov. 18, 2010, the SEC issued Investment Banking Expert Panel testing regarding safeguardinga letter to the AICPA Stockbrokerage recently held a teleconference with the securities and practices and proceduresand Investment Banking Expert Panel PCAOB and the Office of the Chief should be consistent with AT 601reminding auditors of the importance of Accountant of the SEC to discuss the standards and the audit guide.complying with Rule 17a-5 requirements SEC’s Nov. 18 letter. Mark Ramler,that apply when reviewing the Grant Thornton LLP Financial Services 3) Request for guidance onaccounting system and internal control Audit partner, is a member of the panel. measurement standards and viewsprocedures for safeguarding securities on material non-compliance andfor the annual audits of broker-dealer The four major themes discussed on material inadequacy. The PCAOBfinancial statements. The letter states the December 2010 call are as follows: will consider this.that the financial statement audit andthe auditor’s compliance examination 1) Since the 17a-5 is an attestation 4) The SEC said expects to issue aprocedures are critical compliance report, the Expert Panel believed proposal (content to be determinedelements of the SEC’s oversight that there should be assertion- — possibly a compliance examinationof broker-dealers. It also reminds type representation points in the report or an integrated audit report)auditors that Rule 17a-5 requires that management representation letter. for revising and amending Rule 17a-5the “scope of the audit and review… (The PCAOB was neutral on this in the first half of 2011.shall be sufficient to provide reasonable point and did not provide a viewpointassurance that any material inadequacies either way.) The guidance and Potential impactexisting at the date of the examination… examples were expected in January In light of the increased scrutiny ofwould be disclosed,” which is reiterated 2011 from Expert Panel members. The broker-dealers’ audits, broker-dealersin the guidance in the AICPA Audit and management representation points on should expect a lengthier and potentiallyAccounting Guide - Brokers and Dealers custody are very robust. more expensive audit process.in Securities.11 Banking & Securities Update – Winter 2011
  • 12. FASB proposes amended guidance The proposed ASU follows the if the transferor has cash or collateralon accounting for repos SEC’s recently issued Proposed Rule, sufficient to fund substantially all of theThe Board issued proposed ASU, Short-Term Borrowings Disclosure, cost of purchasing replacement securities.Reconsideration of Effective Control for which addresses investors’ concerns The proposed guidance wouldRepurchase Agreements, in November that disclosure of short-term borrowing remove this criterion and its related2010 to improve and simplify the balances as of the balance sheet date implementation guidance from theaccounting for the assessment of effective may not provide an accurate picture of a Codification, thereby reducing thecontrol of repurchase agreements (repos) registrant’s liquidity position, especially criteria that transferors must satisfyand similar instruments. The proposal if the registrant hides its actual liquidity to qualify for secured borrowingresponds to constituents’ concerns that needs by reducing short-term borrowings accounting and likely reducing thecurrent guidance does not adequately shortly before reporting dates. number of transfers accounted for asaddress when transferors should account Currently under FASB ASC sales. The proposed amendments wouldfor repurchase agreements, or other 860-10-40-24, Transfers and Servicing, not affect other criteria that must beagreements that both entitle and obligate a transferor must meet four criteria to satisfied to conclude that sale accountinga transferor to repurchase or redeem maintain effective control of securities is appropriate.financial assets before their maturity, as transferred in a repo and therefore The amended guidance would besecured borrowings rather than as sales. account for the transfer as a secured effective for new transfers and existingThese concerns relate, in part, to reports borrowing rather than as a sale. One of transactions modified as of the beginningthat certain financial institutions had these criteria is that the transferor must of the first interim or annual period afterexecuted repos at the end of a reporting be able to repurchase or redeem the the Board issues the final ASU, which isperiod and accounted for them as sales transferred securities on substantially expected in the first quarter of 2011.under U.S. GAAP to reduce their short- the agreed terms, even if the transferee Comments on the proposed ASUterm borrowings, thereby lowering their is in default. This criterion for secured were due by Jan. 15, 2011.leverage ratios at the reporting date. borrowing accounting is satisfied only12 Banking & Securities Update – Winter 2011
  • 13. Board proposes to converge offsetting The proposed ASU further Under new disclosure requirementsof financial assets and liabilities and clarifies that the right of offset must be that the proposed ASU would require,derivatives enforceable under all circumstances, entities would disclose sufficientBoth the FASB and the IASB issued including during the normal course of information in tabular format aboutproposals on Jan. 28, 2011, on a jointly business and on the default, insolvency, the rights of setoff and collateraldeveloped approach to converge the or bankruptcy of the counterparty. In arrangements associated with eligibleaccounting guidance on when entities addition, the right of offset must be assets and eligible liabilities to enableshould offset eligible assets and unconditional, which means that its financial statement users to understandeligible liabilities on the balance sheet. exercisability must not be contingent the effect of the rights and arrangementsDifferences in offsetting requirements on the occurrence of a future event. on the entity’s financial position.currently create the largest single The offsetting criteria in the proposed The proposed ASU does not specifyquantitative difference between guidance would apply to both bilateral an effective date, but it does indicatestatements of financial position prepared arrangements and to multilateral that the proposed guidance would beunder U.S. GAAP and those prepared arrangements that are between three or retrospectively applied to all periodsunder International Financial Reporting more parties. It would also apply to the presented.Standards (IFRS). offset of one or more eligible assets and The comment period on the Under the proposed guidance, eligible one or more eligible liabilities. proposed ASU ends onassets would be limited to financial assets If the criteria for offsetting are not April 28, 2011.and derivative assets, and eligible liabilities met, eligible assets and eligible liabilities Additional information on thewould consist of financial liabilities would be presented separately, based on proposed guidance is located on theand derivative liabilities. The proposed the nature of the asset and the liability. FASB website, including the newsletterapproach, presented in the FASB’s The proposed ASU also provides that FASB In Focus, “Exposure Draft:proposed ASU, Balance Sheet (Topic 216): a reporting entity would not offset assets Offsetting of Financial Assets andOffsetting, would require a reporting pledged as collateral, or an obligation Liabilities.”entity to offset on its balance sheet a to return collateral, against the relatedrecognized eligible asset and a recognized eligible liabilities and eligible assets.eligible liability if both of the followingconditions apply:• It has an unconditional and legally enforceable right to set off the eligible asset and the eligible liability.• It either intends to settle the eligible asset and eligible liability on a net basis or to realize the eligible asset and settle the eligible liability simultaneously. Simultaneous settlement would occur only when The proposed ASU further clarifies that the right of the transactions are executed at the same moment. offset must be enforceable under all circumstances, including during the normal course of business and on the default, insolvency, or bankruptcy of the counterparty.13 Banking & Securities Update – Winter 2011
  • 14. Broker-dealersFINRA, SEC, PCAOB andcorporate governance updatesRetaining control over customer assets their own due diligence testing. As part Next stepsA clearing broker must retain of this report, broker-dealers would have In order to conduct a reasonableresponsibility for the issuance of to perform an adequate sample test of investigation of securities, broker-dealersinstructions or actual movement of the outsourced activity to ensure it is in will have to develop procedures thatcustomer assets. In addition, the clearing compliance with service-level agreement address the risks associated with thebroker has a responsibility to perform terms. Learn more in Grant Thornton’s investments. Broker-dealers are nowdue diligence on the capability of the Financial Bulletin on the topic. generally distributing and increasingservice provider, including compliance these Regulation D (or Reg D) offeringswith necessary business continuity and Regulatory Notice 10-33, Supplemental to qualified investors to generate profits.retention requirements. FOCUS Information FINRA is concerned that there is a lack In July 2010, FINRA released of due diligence being performed byPotential impact and next steps Regulatory Notice 10-33, Supplemental brokers. RN 10-22 lists the due diligenceBroker-dealers will need to demonstrate FOCUS Information, which expanded best practices for brokers.to both FINRA and the SEC that disclosure of revenue and expense items,any movement of customer assets is as well as the disclosure of the top five Amendment to FINRA Rule 4560, Shortapproved by the regulated broker and underwritings of unregistered offerings. Interest Reportingcompletion of adequate due diligence An amendment to FINRA Rule 4560,on the third-party provider. As a Regulatory Notice 10-22, Obligation of Short Interest Reporting, was recentlybest practice, broker-dealers should Broker-Dealers to Conduct Reasonable proposed by the FINRA Board ofobtain a Service Organization Control Investigations in Regulation D Offerings Governors to ensure consistent reportingReport (such as the AICPA SOC-2 As broker-dealers have been increasing (settlement date) and aggregate shortreport for broker-dealers that already their distributions of private placements, reporting by trade desk. In addition,have a thorough understanding of the FINRA has issued Regulatory Notice short interest reporting should not beorganization and its controls) to validate 10-22, Obligation of Broker-Dealers netted by trade desk within a firm, butthat applicable outsourced activities have to Conduct Reasonable Investigations should be reported on an aggregate basisbeen completed, as well as to support in Regulation D Offerings or RN 10- for each individual trade desk. 22, reminding broker-dealers of their obligation to conduct a reasonable investigation of the offering.14 Banking & Securities Update – Winter 2011
  • 15. PCAOB: Interim audit inspection The PCAOB does not plan to issue Allocation of accounting support feesprogram and funding rules proposed firm-specific inspection reports on The Proposed Rule, Proposal forfor broker-dealers procedures performed under the interim Allocation of the Board’s AccountingThe PCAOB recently released two program before the rules for a permanent Support Fee Among Issuers, Brokers, andProposed Rules to begin implementation inspection program take effect. It expects Dealers and Other Amendments to theof provisions of the Dodd-Frank Act that insights gained through the interim Board’s Funding Rules, would establishthat expand its oversight to encompass inspection program will form the basis classes of broker-dealers for fundingaudits of securities brokers and dealers. for determining the scope and elements purposes, describe the method forThe comment periods for both Proposed of a permanent inspection program, allocating the appropriate portion of theRules end Feb. 15, 2011. including whether to differentiate accounting support fee to each broker classes of brokers and dealers, whether and dealer within each class, and addressInterim inspection program for to exempt any category of public the collection of assessed shares frombroker-dealer audits accounting firm, and what minimum brokers and dealers. The Proposed RuleThe Proposed Temporary Rule for an inspection frequency to establish. would also make certain revisions to theInterim Program of Inspection Related The Proposed Temporary Rule Board’s existing rules for the allocationto Audits of Brokers and Dealers would would not change the SEC rules or of the accounting support fee amongestablish an interim inspection program professional standards that currently issuers. For example, it would amend thefor registered public accounting firms’ govern audits of broker-dealers. As the basis for calculating an issuer’s marketaudits of securities brokers and dealers. SEC has previously explained, its rules capitalization to include the marketThe Proposed Temporary Rule would continue to require those audits to be capitalization of all classes of the issuer’sallow the PCAOB to begin inspecting carried out under generally accepted voting and nonvoting common equity.auditors of brokers and dealers and auditing standards.to address any significant issues inthose audits with the registered firms.At least annually, the PCAOB wouldissue public reports on the progress ofthe interim inspection program and onsignificant issues identified.15 Banking & Securities Update – Winter 2011
  • 16. Broker-dealersTax updateCost-basis reporting Broker-dealers should identifyAs of Jan. 1, 2011, broker-dealers and business processes and systems that willother financial intermediaries are now need to be updated as a result of cost-required to track and report not only basis data requirements — and shouldcost-basis information, but also the prepare implementation strategies,adjusted cost basis of any security that budgets, and project and staffing plans.is sold. Applicable firms must have cost-basis reporting implemented for: State nexus issues States are increasing their collection1) all stock transactions acquired on or procedures for points of revenue after Jan.1, 2011; origination (i.e., customer location)2) all mutual funds and dividend versus the state where the securities were reinvestment plans acquired on or sold (i.e., branch location). It remains to after Jan. 1, 2012; and be seen how this will be applied.3) all financial instruments, such as debt securities and options, acquired on or after Jan. 1, 2013.16 Banking & Securities Update – Winter 2011
  • 17. ResourcesWe provide a number of articles and webcasts on the topic of financial reform and other topics About the publication This Grant Thornton LLP bulletinaffecting the banking and securities industries. provides information and comments on current accounting issues• White paper — Financial reform: How the Dodd-Frank Act affects securitization and developments. It is not a and mortgage lending comprehensive analysis of the subject matter covered and is not intended to• Article — Financial reform and beyond: Key issues for broker-dealers provide accounting or other advice or• Article — Financial reform: Top 10 considerations for broker-dealers guidance with respect to the matters• Article — Financial reform and banks: Top 10 issues to consider addressed in the bulletin. All relevant facts and circumstances, including• Webcast playback — The Dodd-Frank Act and the impact on the banking and the pertinent authoritative literature, securities industry need to be considered to arrive at• FDIC-assisted transactions — Learn more about how to navigate the complexities of these conclusions that comply with matters addressed in this document. transactions from our white papers and webcast playbacks by visiting www.GrantThornton.com/ troubledbanks. Contact For additional information on topics covered in this document, contact your Grant ThorntonYou can also find these materials on our Financial Regulatory LLP adviser or one of the below professionals:Reform Resource Center at www.GrantThornton.com/financialreform. Jack Katz National Managing Partner Financial Services T 212.542.9660 E jack.katz@us.gt.comThe information contained herein is general in nature and based on authorities that are subject to change. It is not intended Nichole Jordanand should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This National Banking and Securitiesmaterial may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and Industry Leaderother tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. T 212.624.5310Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect E nichole.jordan@us.gt.cominformation contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in anyform or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying orusing any information storage and retrieval system without written permission from Grant Thornton LLP.This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at theparticular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thorntonor their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothingherein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matteraddressed. To the extent this document may be considered written tax advice, in accordance with applicable professional regulations,unless expressly stated otherwise, any written advice contained in, forwarded with, or attached to this document is not intended orwritten by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may beimposed under the Internal Revenue Code.17 Banking & Securities Update – Winter 2011