By John Filar Atwood
PCAOB Board member J. Robert Brown, Jr. would like to see improved public disclosure of deficiencies found in the audits of broker-dealers, and wants the Board to consider addressing those deficiencies through changes to its standards. In remarks at a NASAA virtual conference, he highlighted these and other steps the PCAOB can take to improve the protection of customers of broker-dealers.
Brown noted that the PCAOB already contributes to the broker-dealer customer protection regime through oversight of firms that audit registered brokers. Audits can improve the reliability of information filed with regulators, help deter fraud by brokers, and contribute to the protection of customers and their assets, he said.
Improved disclosure. More can be done, according to Brown, and that starts with improving public disclosure of audit deficiencies on a firm-by-firm basis. In his view, this disclosure would provide a significant incentive for audit firms to improve audit quality, and help make brokers aware of the deficiencies in their own audits.
Brown pointed out that for public companies. the PCAOB publishes a report for each inspected firm but no such disclosure occurs in the broker-dealer space. The public company reports identify any deficiencies and certain violations of PCAOB rules and standards. He noted that the deficiency rates disclosed in the reports are followed closely by audit committees and investors, thereby creating an incentive for audit firms to improve audit quality. No such incentive exists for auditors of broker-dealers, he said.
Brown believes that the PCAOB can change this situation relatively quickly. He noted that the existing interim rule requires an annual report about the overall results of the inspection program, and allows for other types of reports such as firm-specific inspection reports in certain circumstances. In his view, years of problematic inspection results justify the issuance of firm-specific reports in order to help improve audit quality.
If the PCAOB issues the individualized reports, Brown believes the content should emphasize information particularly useful to regulators, customers, the public and the broker-dealers that retain the audit firm. Specifically, he suggested disclosure on deficiencies directly relating to the protection of customers and customer assets, including deficiencies in the fraud assessment, and on the identity of the broker-dealer where the deficiency occurred.
Brown said that even if the Board does not resort to individualized inspection reports, it should consider enhancing the disclosure in its annual reports. For example, it could identify the names of the relevant audit firms with respect to each deficiency and publish a table that listed the audit firms inspected and their deficiency rate, he stated. In this way, the Board could at least provide some insight into audit quality of the firms, he added.
Revisions to standards. A second way that the PCAOB could improve the protection of customers of broker-dealers is to consider changes to its standards, Brown said. An area of focus should be the standards governing quality control systems at audit firms, he stated, because the high deficiency rate found in Board inspections suggests that the firms’ current approach to quality control may not be adequate.
Brown suggested that the Board consider specific requirements applicable to audits of broker-dealers to address the high deficiency rate. He acknowledged that this approach is a departure from the usual principles-based approach to standard setting which allows standards to be scalable. However, he believes that the high deficiency rate among broker-dealer audits indicates that this one-size-for-all approach may not be effective.
He noted that in comments received on the concept release on quality control, there was considerable opposition to the idea of specific requirements for audits of broker-dealers in a quality control standard. However, none of the letters from audit firms addressed the high deficiency rate for audits of broker-dealers or suggested alternative mechanisms for improving audit quality, he added. The deficiency rate in broker-dealer audits demands improvement, Brown stated, and a more effective system of quality control may be one way to do it.
Regulatory coordination. Brown’s final recommendation was for the PCAOB to work more closely with other regulators, including establishing regular interaction with state securities regulators and NASAA. When assigning the PCAOB authority to oversee audits of broker–dealers in the Dodd-Frank Act, Congress did not explicitly state that the Board could share information with state securities regulators. This was, Brown believes, an unintended omission that should be addressed in any future revisions of the PCAOB’s enabling statute.
The Board does have some flexibility within the current statutory framework, he said. Specifically, he believes the PCAOB could provide referrals of potential violations by broker-dealers to state securities commissions.
Brown concluded by suggesting that the PCAOB and NASAA meet regularly to discuss mutual concerns. He encouraged NASAA and individual state securities regulators to be proactive in seeking to meet with the PCAOB to consider the protection of broker-dealer customers and other critical issues.