Developments Related to Audits of Brokers and Dealers

I am pleased to be here today to speak with auditors of smaller brokers and dealers in the Miami area about significant developments related to audits of Securities and Exchange Commission-registered broker-dealers.

Today I will provide a brief overview of the regulatory changes currently taking effect for broker and dealer reporting and audits, recent inspection trends from our interim inspection program, as well as observations from the June 30, 2104 year-end broker dealer filings under the new rules and standards. We will cover all of these topics in more detail throughout today’s forum.

Last spring, I had the pleasure of attending PCAOB's Chicago-area forum for smaller broker-dealer auditors. At that forum, I surveyed the recent progress made by the PCAOB in implementing the authorities provided to the Board in the Dodd-Frank Wall Street Reform and Consumer Protection Act to oversee broker-dealer auditors.[1]

In particular, I highlighted significant regulatory reforms promulgated in 2013 related to broker-dealers and their auditors that became effective this year:

  • 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.
  • The Board's 2013 actions followed final SEC rulemaking on amendments to its broker-dealer financial responsibility and annual reporting requirements. Among other things, the SEC adopted amendments to Securities and Exchange Act 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.

These SEC amendments and new PCAOB standards became effective beginning with broker-dealer audits for fiscal years ended on or after June 1, 2014.

The SEC's financial responsibility rules for broker-dealers serve an important investor protection function by requiring broker-dealers 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 implementation details surrounding the new regulatory developments, their impact upon your audits or audit practices, and some preliminary observations on progress so far under the new and amended rules and standards. We are joined today by staff of the SEC, PCAOB, and Financial Industry Regulatory Authority (FINRA), with whom you can discuss these issues from their perspectives.

Results of the PCAOB Interim Inspection Program

On August 18, 2014, the Board issued its third annual report on its interim inspections program.[2] That report described the observations and findings of the PCAOB inspections staff from its 2013 inspections of broker-dealer audits, and it summarized the cumulative results of the inspections through the end of 2013.

Since the inception of the program, PCAOB staff has completed inspections of 101 audit firms, covering portions of 173 audits. The results show a high number of observations in the following areas:

  • Apparent independence violations, whereby 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 certain requirements of Rule 2-01 of SEC Regulation S-X.[3]
  • 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, including those related to revenue, fraud, reports from service organizations, fair value estimates, related parties, and disclosures.

Many of the observations from the inspections conducted in 2013 are similar to those from inspections conducted through the end of 2012. Further, in general, observations were identified across various stratifications of audit firm characteristics, such as whether or not they also audited public companies, and across the spectrum of broker-dealer characteristics, such as reported actual net revenue, revenues, and assets.

However, firms that also audited issuers had a notably lower percentage of observations compared to those that did not. Many of those firms have been subject to PCAOB oversight prior to the start of PCAOB's interim inspection program for auditors of broker-dealers because they audited issuers.

We saw 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. For example, for the nine firms inspected more than once during the interim inspection program, Inspections staff noted a lower percentage of observations when comparing inspections performed during 2013 to inspections performed through 2012. Nevertheless, the number of inspected audits with observations and independence problems remains unacceptably high.

PCAOB's Enforcement Oversight of Broker-Dealer Auditors

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

PCAOB Enforcement investigates matters indicating potentially serious departures from PCAOB audit standards and rules. The rules of the PCAOB provide that the Board may institute disciplinary action against registered firms and their associated persons for violating applicable laws, rules, and professional standards. PCAOB Enforcement focuses its recommendations on serious departures.

Registered firms and associated persons that fail to comply with those standards and rules in the context of audits of brokers and dealers relating to independence, the safeguarding of customer assets and reporting of net capital are of particular interest to Enforcement.

As with many of its investigations relating to issuer audits, PCAOB Enforcement coordinates its broker-dealer audit investigations with the SEC's Division of Enforcement and, as allowed by Dodd-Frank, FINRA.

Recent Progress and Results Related to Broker-Dealer Audits

Against this backdrop of recent inspection findings, the new or amended financial responsibility rules, reporting rules and PCAOB auditing and attestation standards have come 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.

Staff Guidance

On June 26, 2014, the PCAOB issued staff guidance for audits of SEC-registered broker-dealers to assist firms in transitioning to the new PCAOB standards.[4] We are interested in helping firms make an effective transition.

Auditors should be asking themselves two key questions: "do I know what is now required of me" and "do my clients know what is now required of them?"

The staff guidance discusses matters that are new to all registered firms that conduct broker-dealer audits and matters that may be new to firms that have not previously conducted an audit under PCAOB standards. The guidance discusses not only the new attestation standards, it discusses certain aspects of the audit under PCAOB standards that might be unique to broker-dealers and provides examples of how to coordinate the audit, audit procedures related to the supporting schedules, and the examination or review of compliance and exemption reports.

For auditors of brokers and dealers with upcoming calendar year ends, I would emphasize the need to identify an engagement quality reviewer early and ensure that they meet the criteria stated in Auditing Standard No. 7. I would also remind auditors of the importance of complying with SEC independence rules as well as PCAOB independence and ethics rules and standards.

We will spend a significant part of our agenda today discussing the applicable SEC rules and PCAOB rules and standards that are addressed by the staff guidance.

Staff in the PCAOB's Office of the Chief Auditor is available for consultation if you need assistance. (Contact information is located on the cover page of the staff guidance.)

Observations from PCAOB Inspections in 2014

Although all the planned inspections for 2014 under the interim inspection program are not yet complete, the PCAOB's inspections staff have observed audit deficiencies and independence findings similar to those I described earlier related to previous inspections. The audits selected for inspections were for year ends prior to the effective date of the rule amendments and new and amended standards.

PCAOB inspections staff continue to see audit deficiencies related to the requirements of Rule 17a-5, including procedures related to the net capital and customer protection rules. The inspectors also continue to see deficiencies related to the financial statement audit, most frequently in areas such as revenue, fraud, and related parties.

In addition, the inspections staff continue to identify apparent independence violations regarding the auditor's involvement in the preparation of the financial statements. This is disappointing, as we and the SEC staff have been clearly conveying at these forums and through other means that this is prohibited by SEC rule, and yet, the practice persists.

I need to emphasize a point regarding the continuing and pervasive independence findings of our interim inspections program. I continue to hear some auditors suggest that they either disagree with or have difficulty complying with the SEC and PCAOB independence requirements on audits of broker-dealers, particularly the prohibition on auditors providing bookkeeping services.

Quite frankly, it surprises me that some auditors remain challenged in this area that has been so clearly established in SEC's rules for so long.[5] It is unacceptable to "push the envelope" on this issue that is central to the integrity of audits and has been settled for years.

Broker-Dealer Annual Reports under the Amended Rule 17a-5

As I noted earlier, the SEC's 2013 amendments to Rule 17a-5 revised the annual reporting requirements for broker-dealers and the role of auditors in connection with that reporting. These amendments formed the basis for the broker-dealer attestation standards issued by the PCAOB. Starting in 2015, the Board's inspections of broker-dealer audits will be focused on compliance with these standards.

At their core, these amendments require that every broker-dealer file with its annual report either a "compliance report" or an "exemption report," which contain statements by the broker-dealer regarding its internal controls over compliance or the exemption it claimed from Securities and Exchange Act Rule 15c3-3.

These statements are subject to attestation procedures in accordance with PCAOB standards by the broker-dealer's auditor, who would issue an "examination report," for broker-dealer compliance reports, or a "review report," for broker-dealers that file exemption reports. Broker-dealer annual reports must also include financial statements audited in accordance with PCAOB standards.

To obtain an initial impression of compliance levels, staff in PCAOB's Office of Research and Analysis looked at the annual reports filed by broker-dealers with fiscal years ended June 30, 2014. The staff observed the following:

  • Many annual reports did not include the broker-dealer compliance report or exemption report as required by Rule 17a-5.
  • Of the broker-dealers that did not file a compliance report or an exemption report:
    • Some included an auditor's examination report or review report despite the fact that a compliance or exemption report was not filed. In other words, the auditors reported on something that was not included in the broker-dealer's filing.
    • Some filings included the outdated auditor's supplemental report required under the prior rules (concerning material inadequacies in a broker-dealer's internal and other controls).
  • In several cases the audit reports accompanying the broker-dealer financial statements stated that the audit had been conducted under U.S. Generally Accepted Auditing Standards, whereas the SEC now requires that the audit be performed in accordance with PCAOB standards.

These observations underscore my earlier point — auditors of broker-dealers should take steps to ensure that they know what is required of them under SEC rules and PCAOB standards. And while broker-dealers are responsible for their own filings, auditors should consider whether their clients know what is required by the amended Rule 17a-5.

Looking Forward

The PCAOB 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 and amended rules and standards.

Because many of the observations from inspections under the interim program relate to the application of fundamental auditing procedures, these observations continue to be relevant going forward under the new and amended rules and standards.

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. Auditors should take action to prevent the types of deficiencies and findings identified by our inspections.

During this first year under PCAOB standards, auditors of broker-dealers 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. And, as I mentioned earlier, auditors should consider whether their clients know their reporting requirements under the recent amendments to Rule 17a-5.

In the meantime, 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 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.

Corrected Oct. 30, 2014

[1] Developments in the Oversight of Audits of Broker-Dealers, Franzel statement at the PCAOB Forum on Auditing Smaller Broker-Dealers, Chicago, IL, May 28, 2014,

[2] This report, and the Board's first two annual reports, is available on the Board's website at

[3] Broker-dealer auditors are not subject to the partner rotation requirements or the compensation requirements of the Commission's independence rules because the statute mandating those requirements is limited to issuers, and they are not subject to the audit committee pre-approval requirements or the cooling-off period requirements for employment because those requirements only reference issuers.

[4] PCAOB, Staff Guidance for Auditors of SEC-Registered Brokers and Dealers, June 26, 2014,

[5] As the SEC said about the prohibition on auditors providing bookkeeping services to their clients in connection with its amendments to its independence rules in 2003:

"[O]ur independence rules are predicated on the three basic principles enumerated earlier. One of those principles is that an auditor cannot audit his or her own work and maintain his or her independence. When an accounting firm provides bookkeeping services for an audit client, the firm may be put in the position of later auditing the accounting firm's own work. If, during an audit, an accountant must audit the bookkeeping work performed by his or her accounting firm, it is questionable that the accountant could, or that a reasonable investor would believe that the accountant could, remain objective and impartial. If the accountant found an error in the bookkeeping, the accountant could well be under pressure not to raise the issue with the client if raising the issue could jeopardize the firm's contract with the client for bookkeeping services or result in heightened litigation risk for the firm. In addition, keeping the books is a management function, which also is prohibited." SEC Exchange Act Release No. 47265, Strengthening the Commission's Requirements Regarding Auditor Independence, Jan. 28, 2003.