Fact Sheet: Third Report on the Progress of the Interim Inspection Program Related to Audits of Brokers and Dealers

Why the Board is Issuing this Report:

The Public Company Accounting Oversight Board released its third report on the progress of the interim inspection program for auditors of brokers and dealers registered with the Securities and Exchange Commission.

The interim program began in the fall of 2011 in response to the Board's new oversight authority provided in the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Board issued its first two progress reports in August 2012 and August 2013, respectively.

The Interim Inspection Program:

  • Enables the Board to assess the compliance of registered firms and their associated persons conducting audits of broker-dealers with the Sarbanes-Oxley Act, Board and SEC rules, and professional standards.
  • Informs the Board's eventual determinations about the scope and elements of a permanent inspection program.

Inspections of Registered Public Accounting Firms During 2013:

  • Encompasses audits selected for inspection during 2013 that had financial statement periods ended on June 30, 2012 through June 30, 2013.
  • Inspected 60 audit firms reviewing portions of 90 audits of SEC-registered broker-dealers.
  • Finds audit deficiencies or independence findings in 56 of the 60 firms and in 71 of the 90 audits inspected.
  • Of the 60 audit firms inspected:
    • 25 firms were already subject to PCAOB inspection because they audited public companies.
    • 35 firms were not subject to inspection other than under the interim inspection program.

Audit Deficiencies

Audit deficiencies were noted in 55 of the 60 firms inspected and in portions of 70 of the 90 audits selected for inspection (or approximately 78 percent).

The report describes deficiencies observed in the following areas:

  • Audit procedures related to customer protection and net capital under the Exchange Act rules:
    • Accountant's supplemental report on material inadequacies
    • Compliance with customer protection rule
    • Compliance with net capital rule
  • Audit procedures related to financial statement areas:
    • Risks of material misstatement due to fraud
    • Related party transactions
    • Revenue recognition
    • Reliance on records and reports from service organizations
    • Financial statement presentation and disclosures
    • Fair value estimates
    • Evaluation of internal control deficiencies
    • Auditor's report

Independence Findings

Inspections staff found that, contrary to the requirements of SEC independence rules, some auditors were involved in the preparation of the financial statements that they audited.

Independence findings were identified in:

  • Approximately 23 percent (21 of 90) of the audits selected for inspection.
  • Approximately 48 percent (19 of 40) of the audits selected for inspection that were performed by firms that audited broker-dealers but did not audit issuers.
  • 4 percent (2 of 50) of the audits selected for inspection that were performed by firms that audited broker-dealers and also audited issuers.

Summary of Inspections of Registered Public Accounting Firms Since Inception of the Interim Inspection Program

Since inception of the interim inspection program through December 31, 2013, the Board has inspected 101 registered public accounting firms that conducted audits of the financial statements and other requirements of broker-dealers. These inspections covered portions of 173 audits.

Nine of these firms were inspected more than once. Three firms were included in all three reports and six firms were included in two reports.

 

Overall Observations

  • Audit deficiencies or independence findings (collectively "observations") were identified in 151 of the 173 portions of audits selected for inspection (approximately 87 percent).
  • The 22 audits with no observations were performed by 12 firms, 11 of which also audited issuers.
  • Lower percentage of audits with observations identified during 2013 (approximately 79 percent) as compared to inspections performed through 2012 (approximately 96 percent); nevertheless, the percentage of observations was high.
  • High percentage of observations identified based on the number of broker-dealer audits by the firms or whether the firm also audited issuers.
  • High percentage of observations identified in terms of the reported actual net capital, revenues, or assets of the broker-dealers and whether the broker-dealers claimed an exemption under Rule 15c3-3.

Observations by Firm Characteristics

  • Firms that did not also audit issuers were noted to have a higher percentage of audits with observations (approximately 99 percent) than the firms that also audited issuers (approximately 78 percent).
  • Firms that audited 100 or fewer broker-dealers had a higher percentage of audits with observations than firms that audited more than 100 broker-dealers.

Observations by Broker-Dealer Characteristics

  • Generally, there did not appear to be a discernible relationship between the percentage of audits with observations and reported actual net capital, revenues, and assets of the broker-dealers.
  • The percentage of audits with observations for broker-dealers that did not claim an exemption under Rule 15c3-3 (approximately 79 percent) was lower than for audits of broker-dealers that claimed an exemption under Rule 15c3-3 (approximately 90 percent).

Next Steps of the Interim Inspection Program

Future Inspections

  • During 2014, the Board plans to inspect approximately 60 firms and portions of approximately 100 audits.
  • The Board may inspect audits of broker-dealers whose past audits were previously inspected. In that context, the Board may evaluate whether, or how, the firms addressed audit deficiencies or independence findings from the previous inspection.
  • During 2015, the Board will inspect audits of broker-dealers, which are required to be performed in accordance with PCAOB standards, in order to assess compliance with the applicable standards and rules.

Scope of a Permanent Inspection Program

  • The Board is continuing to take a careful and informed approach in establishing a permanent inspection program.
  • The Board recognizes the complexity and diversity of the broker-dealers, as well as the challenges in obtaining relevant information for these nonpublic companies.
  • The Board continues to obtain available information to evaluate the risk of loss to customers and whether this risk can be assessed from attributes that characterize broker-dealers in an effort to provide for differentiation of the broker-dealers.
  • The Board plans to review the contents of the compliance and exemption reports and the respective auditors' reports related to the broker-dealers' compliance with the provisions of the customer protection rule, to evaluate risk of loss to customers.
  • The Board also will continue to gather information regarding customer losses due to fraudulent activities or liquidations of broker-dealers, and regulatory sanctions imposed on broker-dealers to evaluate whether correlations exist between these matters and characteristics of the broker-dealers.
  • The Board anticipates issuing a proposal for a permanent inspection program in 2016.

Other Initiatives

  • The Board will continue to conduct forums for auditors of broker-dealers that provide information about the Board, the interim inspection program, observations from the interim inspection program, and audits of broker-dealers.
  • The Board will participate in various outreach initiatives, including conferences and other events to inform registered public accounting firms that issue audit reports for broker-dealers about observations from the interim inspection program, developments in the Board's standard-setting initiatives, and updates from the SEC and FINRA.
  • The Board will issue guidance for audits of broker-dealers and will consider using communication tools such as webcasts and stored media presentations to effectively deliver guidance and information to auditors of broker-dealers.

Staff Guidance for Auditors of SEC-Registered Brokers and Dealers was issued on June 26, 2014.

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