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 Developments in the Oversight of Audits of Broker-Dealers

DATE May 28, 2014
SPEAKER(S): Jeanette M. Franzel, Board Member
EVENT: PCAOB Forum on Auditing Smaller Broker-Dealers
LOCATION: Chicago, IL

I am pleased to be back in Chicago to speak with auditors of smaller brokers and dealers about significant developments in the Board's oversight of audits and auditors of Securities and Exchange Commission-registered broker-dealers. I last participated in a forum for Chicago-area broker-dealer auditors in April 2012, which was the third such forum conducted by the PCAOB — and the first of four in 2012.[1]

The PCAOB has made significant strides in implementing the authorities provided in the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 for the Board to oversee broker-dealer auditors. In addition to promulgating rules for the registration of these auditors and for their funding and certain reporting obligations, the Board, in 2011, established an interim program for inspecting broker-dealer auditors.

In 2013, the Board adopted new auditing standards for broker-dealer audits and certain amendments to its rules to conform them to the broker-dealer audit context.[2] The Board's 2013 actions followed final SEC rulemaking on amendments to its broker-dealer financial responsibility and annual reporting requirements.[3] Among other things, the SEC adopted amendments to SEC Rule 17a-5 to strengthen and clarify broker-dealer financial reporting requirements and also require that broker-dealer audits be conducted in accordance with PCAOB standards.

The SEC's financial responsibility rules for broker-dealers serve an important investor protection function by requiring them to maintain minimum levels of net capital and take steps to safeguard customer securities and cash. And the involvement of auditors — under PCAOB oversight and using PCAOB standards -- should enhance the quality of information provided to the SEC for its regulatory oversight, which is important to the protection of investors who entrust broker-dealers with their cash and securities.

Today, we will discuss the details of these developments and their impact upon your audit or audit practices. We also will discuss the PCAOB's observations from its interim inspection program, which is now in its third year.

As the forum gets underway, I would like to begin by highlighting, in particular, the PCAOB's progress under its interim inspection program and what that progress means to registered firms that audit broker-dealers.

Broker-Dealer Auditors and the PCAOB Interim Inspection Program

The PCAOB began inspecting auditors of broker-dealers under its interim inspection program in late 2011, and has issued two annual reports summarizing its inspections.[4] We are nearing completion of our third year of inspections. Our inspections to date have focused on compliance with applicable Board rules, SEC rules, and professional standards that were in effect before the SEC's amendments to Rule 17a-5. As contemplated in the Board's rules, we plan to issue our third report in August 2014.[5]

As of May 2013, there were 783 registered firms that issued audit reports on the fiscal year-end 2012 financial statements of broker-dealers that were filed with the SEC. They audited 4,227 broker-dealers. These numbers are down from the 2011 reporting cycle, which involved approximately 800 firms that issued audit reports on approximately 4,400 broker-dealers. These numbers will be updated for 2013 filings in our third annual report.

Since we began inspecting auditors of broker-dealers under our interim inspection program, through the year 2013:

  • We completed inspections of approximately 100 audit firms.
  • Nearly 13 percent of firms that audit broker-dealers were inspected.

Our results for all three years show a high number of observations in the following areas:

  • Apparent independence violations, in which auditors were involved in the preparation of the financial statements that they audited. As with issuer auditors, the auditors of broker-dealers have been — and continue to be — required to be independent in accordance with Rule 2-01 of SEC Regulation S-X.[6]
  • Deficiencies related to other requirements of Rule 17a-5, including customer protection and net capital rules.
  • Deficiencies in the audit work for the financial statements.

Many of the observations from the inspections conducted in 2013 are similar to those from inspections in 2011 and 2012.

Although we are seeing some improvements in the number of inspected audits with independence problems and certain types of audit deficiencies when comparing 2013 results to prior years' results, the number of inspected audits with these types of observations remains unacceptably high.

Many of the observations relate to the application of fundamental auditing procedures. Firms need to take steps to improve the quality of their broker-dealer audits to achieve compliance with applicable rules and standards and the overall goals of protecting investors and the public interest.

As part of our interim inspection program, information from our inspections may lead to investigations or disciplinary proceedings concerning the conduct of the audit firm or associated persons of such firms.

Information related to possible violations of laws or rules, including independence rules, by broker-dealers may be, and have been, reported to the SEC and other regulators.

Looking Forward

Against this backdrop of inspection findings, the new or amended financial responsibility rules, reporting rules, and PCAOB auditing and attestation standards are coming into effect for broker-dealers and their auditors.

The new PCAOB standards are designed to further the public interest and promote investor protection because they are tailored to the corresponding requirements of SEC Rule 17a-5, which are designed to provide safeguards with respect to broker-dealer custody of customer securities and funds.

The PCAOB plans to issue staff guidance for audits of smaller broker-dealers in the very near future to assist firms in transitioning to the new PCAOB standards, which are effective for audits with fiscal years ending on or after June 1, 2014.

The Board will continue to conduct inspections under the interim inspection program of registered public accounting firms that audit broker-dealers until rules for a permanent inspection program take effect. Our interim inspection program will likely be extended as broker-dealers and their auditors transition to and implement the new rules and standards.

In the meantime, it is imperative that auditors of broker-dealers ensure that they are complying with SEC independence rules.

Auditors of broker-dealers also need to ensure that they conduct their audits in accordance with applicable auditing standards and other SEC rules, and obtain sufficient audit evidence to support the reports they issue.

Auditors should take action to prevent the types of deficiencies and findings identified by our inspections and to plan and execute their audits in accordance with PCAOB standards and SEC rules.

The PCAOB Forums on Auditing Smaller Broker-Dealers provide an excellent opportunity to discuss these issues with the expert staff of the PCAOB, SEC, and the Financial Industry Regulatory Authority (FINRA). These forums also provide all of us with important insights from auditors and practitioners. I encourage you and other broker-dealer auditors to take advantage of this opportunity, and I look forward to our discussions today and in the future.

* The views expressed are my own, and not necessarily those of the Public Company Accounting Oversight Board, of any other Board member, or of the Board's staff.

[1] http://pcaobus.org/News/Speech/Pages/04262012_FranzelBDForum.aspx. The PCAOB held its first two forums in 2011 in conjunction with the implementation of its newly established interim program for inspecting broker-dealer auditors.

[2] For additional background information on the Board's activities, see http://pcaobus.org/News/Speech/Pages/10102013_Franzel_AuditingStandard.aspx. See also, SEC Exchange Act Release No. 34-71525, Feb. 12, 2014 (approving PCAOB standards) and SEC Exchange Act Release No. 34-72087, May 4, 2014 (approving PCAOB's conforming amendments rulemaking).

[3] See SEC Exchange Act Release Nos. 34-70072 and 34-70073, July 30, 2013.

[5] See PCAOB Rule 4020T(d).

[6] In addition, effective June 1, 2014, broker-dealer auditors also must comply with PCAOB ethics and independence requirements.