By John Filar Atwood
The SEC’s Office of Investor Education and Advocacy (OIE) cautioned crypto investors that “proof of reserves” reports issued by some crypto asset trading platforms and issuers are not equivalent to financial statement audits and lack important investor protections. In an Investor Bulletin developed in conjunction with the Office of the Chief Accountant, the OIE advised investors not to place the same degree of reliance on these types of reports as they would on audited financial statements.
The bulletin memorializes July 27 remarks by SEC Chief Accountant Paul Munter about the potential pitfalls of crypto assurance work, as previously reported in Securities Regulation Daily. In that statement, Munter advised that accounting firms must ensure that their names and services are not being used to convey a false sense of legitimacy or to mislead investors, particularly emphasizing that a non-audit review of a crypto firm’s work is not at parity with a financial statement.
The bulletin extends its cautionary message beyond “proof of reserves” reports to “valuation” or “calculation” reports that may be used in other industries. Contrary to how they have sometimes been portrayed, proof of reserves, valuation, and calculation reports are not audit reports as defined by the PCAOB and the SEC, the bulletin states.
Differences between audited and non-audit reports. Key differences include that proof of reserves, valuation, and calculation reports may have no specific requirements for the engagement or the information reported, allowing an entity full discretion to manage the terms of the engagement, the OIE stated. A proof of reserves report, for example, does not include a complete set of financial statements and does not tell investors the whole story about the entity’s liabilities.
Further, the bulletin notes that unlike financial statement audits, which can only be performed by registered accounting firms, proof of reserves, valuation, and calculation reports may be provided by either registered or unregistered accounting firms, or by another third party, and often provide no assurance as to the reliability of the information provided.
A third difference is that even when provided by a registered accounting firm, proof of reserves, valuation, and calculation reports may fall outside of PCAOB regulatory oversight, and may not be subject to PCAOB standards, inspections, or enforcement proceedings. The bulletin warns crypto investors that registered accounting firms may provide services that are not subject to PCAOB standards.
The bulletin further advises that firms providing proof of reserves, valuation, and calculation reports may not be subject to the same independence requirements as firms providing audits that are subject to SEC rules. Independence standards generally ensure that an auditor will exercise objective and impartial judgment with respect to an audit, the OIE notes.
Recognizing an audited report. The bulletin provides guidance on how to recognize if a registered accounting firm has conducted an audit under the PCAOB’s standards. As an initial matter, an audit report on the financial statements of a public company or registered broker-dealer includes a pass/fail opinion on whether the company’s financial statements fairly present its financial position, results of operations and cash flows, the OIE stated.
In addition, the report must be titled “Report of Independent Registered Public Accounting Firm” and must clearly state whether the audit was conducted in accordance with PCAOB standards. The bulletin notes that the audit report will also state whether the auditor is providing an unqualified opinion or a qualified opinion, in which the auditor expresses disagreement with some of the information in the financial statements.
The OIE emphasized that even if a report is labeled as an “audit report” or “attestation report,” if it does not clearly state that the audit was conducted in accordance with the standards of the PCAOB it is not an audit report under PCAOB standards.
Red flag. Finally, the bulletin states that investors should consider it a red flag if an entity portrays non-audit services, such as proof of reserves reports, as equivalent, or superior, to audits meeting PCAOB standards. Using terms such as “GAAP audit” or “Valuation Audit” to describe the services are some examples of potentially misleading information, the OIE said.
The bulleting further warns that entities and associated individuals may exacerbate confusion by touting “successful” audits. The OIE strongly cautions investors that those reports are different from, and should not be taken as a substitute for, audits conducted by registered public accounting firms under PCAOB standards. Only audits performed by registered public accounting firms and conducted in accordance with PCAOB standards have all of the investor protections mandated by the PCAOB and SEC, the bulletin concludes.