Tuesday, August 28, 2018

PCAOB report: Fewer independence violations, but audit deficiencies remain high in broker-dealer audits

By Amanda Maine, J.D.

The PCAOB’s report on its 2017 inspections of auditors of brokers and dealers reveals that while staff found fewer independence violations, the overall number of audit deficiencies remained high. According to the PCAOB, the collective efforts of inspections, enforcement actions, and outreach through the Board’s forums and webinars have helped auditors with compliance in the area of independence. The Board also recommended that broker-dealer owners and their audit committees engage in meaningful dialogue to take appropriate steps in avoiding deficiencies in the future.

Inspections. The PCAOB’s interim inspection program of broker-dealer audits involved 75 firms that audited broker-dealers and covered portions of 116 audits and related attestation engagements. In its report, the Board cautioned against extrapolating from the results presented and noted that the deficiencies discussed in the report are not necessarily representative of all audits of broker-dealers.

Independence. According to the report, the staff found that 8 percent of broker-dealer audit firm inspections in 2017 contained independence impairments. Three of the four audits identified by the Board as having independence impairments related to auditing firms having performed bookkeeping or other services related to the broker-dealer’s accounting records, or having prepared or assisted in the preparation of the broker-dealer’s financial statements. The fourth audit was impaired due to an indemnification clause in the firm’s engagement letter stating that the broker-dealer would indemnify the firm when there was knowing misrepresentation of information by the broker-dealer’s management.

Audit deficiencies related to the financial statements. Audit deficiencies relating to revenue continue to be an issue, according to the report. The staff found deficiencies in 65 percent of applicable audits, compared to 66 percent in 2016. Risk assessment procedures and the extent of firms’ testing of revenue transactions were the most common categories of deficiencies related to revenue.

Inspections staff also identified audit deficiencies related to assessing and responding to risks of material misstatement due to fraud in 64 percent of audits, compared to 57 percent in 2017. Regarding the auditing of financial statement presentation and disclosure, the staff found deficiencies in 33 percent of audits, down slightly from 2016’s 39 percent. The report noted that in 16 of 26 audits, firms did not identify and evaluate instances pertaining to related party relationships and transactions.

The staff identified audit deficiencies regarding related-party relationships and transactions in 32 percent of the audits, holding steady with last year’s 33 percent. Deficiencies relating to auditing fair value measurements rose slightly from 24 percent to 28 percent.

Engagement quality review. According to the report, inspections staff identified deficiencies related to the engagement quality review in 55 out of 93 audits, or 59 percent. The previous year featured a similar statistic of 57 percent. The report noted that in five of the broker-dealer audits inspected, an engagement quality review was not performed and that these firms did not audit issuers. In general, firms that also audited issuers had fewer audit deficiencies than those that only audited broker-dealers and non-issuers. The staff also observed that the engagement quality review was insufficient in 50 audits.

Examination procedures. Deficiencies relating to examination procedures of applicable attestation engagements held steady at 70 percent, according to the report. The most common deficiency relating to examination procedures was testing controls over compliance, followed by performing compliance tests and planning the examination.

Recommendations. The Board’s Executive Highlights of the report included recommendations for auditors of broker-dealers to improve their quality control systems. The Board advises firms to enhance and maintain their policies to ensure that the audit firm is independent; determine that a qualified reviewer performs the engagement quality review; and emphasize the importance of appropriate supervision. 

The Board also pointed out the areas with the highest percentage of deficiencies: auditing revenue; assessing and responding to risks of material misstatement due to fraud; the customer protection rule; engagement quality review performed by a qualified reviewer; and proper examination procedures, including testing controls over compliance with the financial responsibility rules.