The PCAOB issued its annual report on its interim inspection program related to the audits of broker-dealers. The report, which covers inspections of broker-dealer audits in 2020, found that while the number of firms that had one or more audit and/or attestation engagements with deficiencies declined slightly, the number still remained high as a percentage of firms inspected. The report also identified a number of "good practices"—scenarios encountered by inspections staff offered as examples of how firms effectively addressed certain audit issues.
Firms and engagements inspected. Financial statement audits of firms registered with the SEC as both a broker and a dealer or as only one or the other are subject to the PCAOB’s inspection program unless the firm qualifies for an exemption. In 2020, out of 3,309 broker-dealer audits at 360 firms, the staff selected 65 firms and 105 financial statement audits for inspection. When selecting which firms to inspect, the staff used a risk-based approach that took into account several considerations, including the number of broker-dealer audits performed, whether the firm also issued audit reports for issuers, and the existence of disciplinary actions against the firms or its partners. The staff also used a risk-based approach when selecting engagements for review, but also made random selections to provide an element of unpredictability.
The report notes that the deficiencies identified in the report do not necessarily mean that the broker-dealer’s financial statements were not fairly stated, nor does the selection of firms constitute representative samples of the firms that audit broker-dealers.
Inspections observations. Regarding deficiencies in examination engagements, during which an auditor must plan and perform an examination statements made by the broker-dealer in its compliance report, out of the 21 engagements reviewed, the staff found 14 engagements with deficiencies at 67 percent, fairly consistent with the previous two years 69 percent and 75 percent. Among the deficiencies identified by the staff in this area, the report notes that testing of internal control over compliance continues to drive high deficiency rates. For example, several firms did not perform, or did not sufficiently perform, tests of compliance with the Reserve Requirements Rule.
In comparison, deficiencies in review engagements fell dramatically, according to staff inspections. In a review engagement, the auditor must plan and perform the review of the assertions made by the broker-dealer in its exemption report. Out of 85 applicable engagements, the staff found 19 with deficiencies for a rate of 23 percent compared to 51 percent and 54 percent in 2019 and 2018.
The staff’s review of financial statement audits found once again that deficiencies in auditing revenue continue to drive high deficiency rates in audit engagements, in particular responding to the risk of material misstatement. The report identifies a number of instances when firms did not perform adequate procedures when auditing common sources of broker-dealer revenue, including:
- Commissions (insufficient testing of whether the commission recorded was accurate);
- Trading gains and losses (insufficient testing of data from the broker-dealer’s proprietary trades;
- Investment banking fees (insufficient testing of whether the transactions had occurred); and
- Advisory fees (insufficient testing of the accuracy of related balances and whether the fee rates were consistent with the terms of the broker-dealer’s contract with the customer).
Several firms lacked sufficient risk assessment procedures, which contributed to deficiencies in the financial statement audit, the report found. These included failure to evaluate the design of broker-dealer controls intended to address fraud risks and whether those controls had been implemented and failure to obtain a sufficient understanding of the broker-dealer’s internal control over financial reporting, including information systems. Some firms did not address identified risks of material misstatement because they performed insufficient audit procedures involving related-party transactions, such as expenses allocated between the broker-dealer and their parents or affiliates.
Good practices. The report highlights several "good practices" made by audit firms that were identified by the staff. The PCAOB encourages auditors to consider how these examples may apply to their own broker-dealer engagements. In the area of revenue, an auditor identified a fraud risk related to improper revenue recognition for commissions. In response, the auditor evaluated the design of the broker-dealer’s controls to ensure that revenue was recognized on a trade date basis and that the amounts were consistent with the terms of the broker-dealer’s agreements with its customers. The auditor also selected a sample of customer trades and tested the accuracy of the price and quantity associated with the trade for each selection.
In another good practices example involving the Customer Protection Rule, an auditor tested controls over the accuracy and completeness of information in the broker-dealer’s deficit report, including controls over segregation instructions and control locations. The auditor also selected a sample of deficit reports and inspected evidence of management review, which revealed that management had taken action to resolve the deficits within the timeframe required by the Customer Protection rule.
The report also identified good practices involving performing the review engagement. In this instance, the broker-dealer stated in its exemption report that it engaged in other business activities that were limited to proprietary trading and receiving transaction-based compensation for identifying potential merger and acquisition opportunities for clients. In response, the auditor obtained an understanding of the broker-dealer’s business activities and took that understanding into account when assessing whether the broker-dealer conducted other business activities that should have caused the broker-dealer to either claim an additional exemption or to provide disclosures related to additional business activities in its exemption report.