Saturday, February 26, 2011

Large Audit Firms Seek Clarification of PCAOB’s Proposed Temporary Inspection Program for Auditors of Brokers

Large audit firms generally support the PCAOB’s proposal to establish an interim inspection program related to audits of brokers and dealers and believe that the temporary program will allow the Board to achieve its objective of informing the permanent inspection program. However, the firms seek clarification from the Board on how some aspects of the interim inspection program will work in practice. Further, the firms believe that the permanent inspection program should classify brokers by risk. Section 982 of the Dodd-Frank Act expanded the PCAOB’s inspection authority to include audits of securities brokers and dealers. The Board has proposed a temporary inspection program designed to allow the Board to begin inspection work on audits of broker and dealers without waiting to help it in making fully informed judgments about a permanent program.

While the Board should include registered accounting firms and all types of brokers and dealers in the scope of its temporary program, noted KPMG, the Board should consider the costs and benefits of adopting a permanent inspection program that scopes in all types of brokers and dealers. KPMG urged the Board to focus on brokers and dealers that carry customer accounts and maintain customer cash and securities. These clearing brokers are typically considered to represent greater significance to the markets and investors than introducing brokers, emphasized KPMG, whose customer accounts and transactions are cleared and carried on the books and records of a clearing broker. In its comments, Grant Thornton encouraged the Board to develop a risk profile for the various classes of brokers and focus the inspections on those deemed of higher risk. In that regard, GT suggested that the Board get input from industry and professional groups to assist in identifying and weighting the appropriate risk factors.

KPMG supports the Board’s intention of publishing the results of the interim program’s progress no less frequently than every twelve months since the reports will help improve audit quality. But the reports should not only describe the progress of the program and any significant observations that may bear on the Board’s consideration of a permanent program, said KPMG, but should also include sufficient details on the nature and types of brokers and dealers inspected relative to the observations made to allow accounting firms to improve their audits of brokers and dealers by improving their understanding of the specific issues raised in the reports.

Although the Board refers to a draft inspection report, noted KPMG, it has not incorporated Rule 4007 dealing with procedures on draft inspection into Rule 4020T and the proposed interim inspection program. Further, the proposal does not discuss any provisions for the issuance of a draft inspection report or procedures to allow an audit firm to respond to inspection findings during the program period.

KPMG also seeks clarification on how the Board will report inspection deficiencies in such reports. Specifically, during the course of the program it is not clear how findings will be communicated to the firm, what opportunities the firm will have in responding to such findings, or the timing and extent to which interim inspection findings will be communicated in firm-specific public reports. Similarly, McGladrey & Pullen recommend that the Board articulate in Rule 4020T how it intends to communicate identified audit deficiencies throughout the interim inspection period and what the Board’s expectations are for the firm in responding to any deficiencies.

More broadly, KPMG believes that publicly issuing firm-specific reports during the program period would be inconsistent with the Board’s expectation that inspection procedures performed on a firm as part of the program are to constitute a foundational portion of the inspection of the firm’s broker and dealer audit practice, which eventually would be completed and encompassed within a firm-specific inspection report following the establishment of the permanent program if the firm is included in the permanent program.

Both KPMG and McGladrey noted that, given that SEC rules with respect to reports to be made by brokers may be revised, and that the Board may revise standards with respect to the audits of brokers during the interim program period, publicly disclosing firm-specific inspection findings for certain firms during the interim period may not be beneficial to investors since the inspection findings may be based upon regulations that are no longer in effect at the time of issuance of the firm-specific inspection report and would not serve to help improve the quality of future audits.

McGladrey observed that such disclosure would not serve the two principal purposes of the proposed rule of allowing the Board to assess current compliance rules and standards in performing audits with respect to brokers and informing the Board’s decision about significant elements of a permanent inspection program. McGladrey urged the Board to state in the “Reporting” section of Rule 4020T under which circumstances it would incorporate interim inspection findings in firm-specific inspection reports

KPMG also said it is unclear what program observations the Board intends to include in the initial firm-specific report released after a permanent program takes effect. Although KPMG expects that the Board would only publish observations noted during the
program period that would have an impact on an accounting firm going forward, the
Release does not address what specifically the Board intends to include in the initial firm-specific public report. For example, it is not clear as to whether potential deficiencies cited in a firm-specific report will be cumulative over the course of the three years of the program.

Similarly, McGladrey found it unclear whether the initial firm-specific reports issued after the rules for a permanent program take effect will include inspection comments on a cumulative basis over the three years of the interim inspection program. If comments are cumulative, inspection deficiencies related to standards that have been amended and are no longer relevant could be included. Also, cumulative reporting would result in significant reporting time lags, including the potential for reporting of inspection findings that have been satisfactorily addressed subsequent to the interim inspection. Public disclosure of inspection deficiencies related to outdated standards or deficiencies that have already been satisfactorily addressed could be misleading. Thus, the firm urged the Board to clarify its intentions regarding the nature of what will be communicated in the initial firm-specific public report after the permanent program takes effect.

While GT agreed with the proposed mechanisms for providing feedback to the inspected firms and the issuance of a formal report describing the progress of the temporary inspection program and the Board’s significant observations, the firm recommend that the Board keep separate the process for reporting on inspections of a firm’s audits of issuers out of concern that combining the communication of findings may result in report issuance delays and potential confusion in interpreting the PCAOB’s comments.

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