Thursday, August 20, 2015

PCAOB Continues to Find Deficiencies in Audits of Broker-Dealers

By Jacquelyn Lumb

The PCAOB has issued an annual report on its interim inspection program for the audits of brokers and dealers in which it reported that unacceptably high levels of deficiencies continued to be found despite the Board’s outreach and guidance efforts. The Board said it was particularly concerned about the lack of due professional care in the conduct of some of the audits, based on the lack of attention to the SEC’s rule requirements and the lack of professional standards in planning and performing procedures on some of the engagements. The report includes the Board’s observations from 106 audits conducted by 66 firms that took place in 2014, summarizes its observations since the inception of the interim inspection program in October 2011, and includes observations from seven audits in which deficiencies were identified in a previous inspection (Release No. 2015-006, August 18, 2015).

GAAS audits. The annual report covers audits that were required to be performed under generally accepted auditing standards that were applicable before the SEC amended its rules to require audits of brokers and dealers to be performed in accordance with PCAOB standards. Last year, the Board also inspected five firms that were required to conduct audits under the PCAOB’s standards and issued a report on those audit observations on January 28, 2015. Those engagements are not included in the annual report.

Selection process. The Board selected firms for inspection based on the number of broker or dealer audits they performed, whether they also issued audit reports for issuers, which would subject them to regular PCAOB inspections, and considered other characteristics in order to review a cross-section of firms. The Board advised that its observations are not necessarily indicative of the full population of firms or audits.

Deficiencies found at all 66 firms. Twenty-seven of the firms that were inspected audited issuers as well as broker and dealers, so they were subject to regular inspections by the Board. The Board reported that it identified deficiencies at all 66 firms that were inspected and in portions of 92 of the 106 audits. In reviewing the seven firms’ audits where deficiencies had previously been identified, the staff found at least one deficiency in the same area as previously identified in each of the seven audits. The deficiencies related to revenue recognition, risks of material misstatements due to fraud, related party transactions, and the net capital rule.

Independence violations. The inspection team found that in 26 of the audits, auditors were involved in the preparation of the financial statements they audited, or the terms of the engagement included an indemnification of the auditor in the event that losses occurred, both of which are contrary to the SEC’s independence rules. The Board advised that it reports independence violations to the SEC since they may affect the broker’s or dealer’s compliance with Exchange Act Rule 17a-5. The Board said the independence violations were particularly troubling given the SEC’s long-standing rules with respect to a firm’s involvement in the preparation of financial statements.

Most frequent deficiencies. According to the annual report, the most frequent deficiencies involved revenue recognition, reliance on records and reports, fair value accounting estimates, financial statement presentation and disclosures, and the customer protection rule.

Potential disciplinary action. The Board said that many of the inspected firms need to significantly improve their audit work and reminded firms that information that is obtained during the interim inspection program may lead to an investigation or a disciplinary proceeding. For example, the Board has settled disciplinary orders against 14 audit firms for violating the independence rules as of the date of the annual report.

The Board also reports to the SEC and the designated examining authorities when it finds financial statements that are not fairly stated in conformity with GAAP or where there are possible violations by brokers or dealers of laws, rules or regulations. The SEC announced last December that it had settled actions for violations of the independence rules against eight audit firms, which were not the same firms that reached settlements with the Board.

The Board urged firms to re-examine their audit approaches, read the annual report to see whether they need to take any corrective actions, and review the staff guidance the Board issued for auditors of SEC-registered brokers and dealers.

Permanent inspection program. The staff currently plans to develop a proposal for a permanent inspection program for brokers and dealers in 2016. The proposal will address whether to exempt any category of registered public accounting firm.

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